Callable vs Bullets: Performance History Parth Bhatt – Investment Officer, County of San Bernardino 1 0 1 2 3 4 5 6 7 8 Jun-00 Oct-00 Feb-01 Jun-01 Oct-01 2 Feb-02 Jun-02 Source: Bloomberg Oct-02 Feb-03 How How much did $10 Million invested in $10 Millioninvested ina 1 Callables Jun-03 $16.084 Million by Oct-03 Feb-04 BAML 1 Jun-04 Bullets (1 -5 Year) -5 (1 Bullets Oct-04 Feb-05 Jun-05 Oct-05 - 5 Year US Non Feb-06 Jun-06 YieldSpread Oct-06 out yieldedbullets Feb-07 Yieldto Maturity Jun-07 Oct-07 Feb-08 Jun-08 - Oct-08 Bullet Agency Index & BAML 1 Callables(1-5 Years) Feb-09 Jun-09 Oct-09 May 2017. Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 - Jun-12 5 year Oct-12 Feb-13 Jun-13 from Oct-13 Feb-14 Jun-14 - Oct-14 callable only 5 Year US Year US 5 BulletAgency Index Feb-15 Jun-15 2000 June Oct-15 Feb-16 Jun-16 an agency Oct-16 Feb-17 0.2 0.4 0.6 0.8 1.2 1.4 1.6 1.8 0 1 2 Jun-00 to Dec-00 portfolio Jun-01 May 2017 bullets only portfolio turn into? turn bulletsportfolio only Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 in June 2000 Jun-04 Dec-04 48 by b Jun-05 Bullet - CallableBullet Spreads - Dec-05 Jun-06 Yield to Maturity Dec-06 ps, Jun-07 Spread Dec-07 turned into Jun-08 on Dec-08 Jun-09 average. Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 3 It’s a Trick Question 1-5 year treasury and agency bullets only portfolio turns into $19.128 Million. Bullets out-performed by $3.44 Million. How much does a 1-5 year treasury only portfolio turn into? Money Growth $19.12 Million $20,000,000.00 $19,000,000.00 $18,000,000.00 $17,000,000.00 $16,000,000.00 $15,000,000.00 $16.08 Million $14,000,000.00 $13,000,000.00 $12,000,000.00 $11,000,000.00 $10,000,000.00 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Oct-00 Feb-01 Oct-01 Feb-02 Oct-02 Feb-03 Oct-03 Feb-04 Oct-04 Feb-05 Oct-05 Feb-06 Oct-06 Feb-07 Oct-07 Feb-08 Oct-08 Feb-09 Oct-09 Feb-10 Oct-10 Feb-11 Oct-11 Feb-12 Oct-12 Feb-13 Oct-13 Feb-14 Oct-14 Feb-15 Oct-15 Feb-16 Oct-16 Feb-17 Bullets (1 -5 Year) Callables (1-5 Years) Source: Bloomberg BAML 1-5 Year US Non-Bullet Agency Index & BAML 1-5 Year US Bullet Agency Index 4 Treasuries Only? 1-5 year treasury only portfolio turns into $17.73 Million. Treasuries out-perform callable agencies by $1.64 Million. $19.12 Million $17.73 Million $16.08 Million Source: Bloomberg BAML 1-5 Year US Non-Bullet Agency Index, BAML 1-5 Year US Bullet Agency Index & BAML 1-5 Year US Treasury Index 5 Why do callables that out yield bullets significantly underperform bullets with respect to total return? 6 Source: Bloomberg 0.5 1.5 2.5 1 2 3 0 BAML 1 Jun-00 - 5 Year US Non Nov-00 Duration Apr-01 Sep-01 Feb-02 - Bullet Agency Index & BAML 1 Jul-02 Dec-02 May-03 Bullets (1 -5 Year) -5 (1 Bullets Oct-03 Mar-04 Aug-04 Jan-05 – Jun-05 Nov-05 Callables - 5 Year US Year US 5 BulletAgency Index Apr-06 DurationInstability Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Callables(1-5 Years) Aug-09 Jan-10 vs Bullets Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 7 Bullet – Duration vs Yield Duration & Conv exity 3 7 2.5 6 5 2 4 1.5 3 1 2 0.5 1 0 0 Jul-04 Jul-11 Jan-01 Jan-08 Jan-15 Jun-00 Jun-07 Jun-14 Oct-02 Oct-09 Oct-16 Apr-06 Apr-13 Feb -0 5 Sep -0 5 Feb -1 2 Sep -1 2 Dec-03 Dec-10 Aug-01 Aug-08 Aug-15 Nov-06 Nov-13 Mar-02 Mar-09 Mar-16 May-03 May-10 May-17 Bullets (1 -5 Year) Duration 5 Year Treasury Yield No correlation between yield and duration in the case of bullets. Source: Bloomberg BAML 1-5 Year US Non-Bullet Agency Index & BAML 1-5 Year US Bullet Agency Index 8 Source: Bloomberg 0.5 1.5 2.5 BAML 1 0 1 2 3 As yieldsrise, bonds become more interestrate sensitive. Callablebonds share exactly the opposite relationshipwithduration than do bullets. High positive correlation between yields and Jun-00 - 5 Year US Non Nov-00 Duration Apr-01 Sep -0 1 Feb -0 2 - Jul-02 Bullet Agency Index & BAML 1 Dec-02 May-03 Oct-03 Mar-04 Aug-04 Jan-05 – Jun-05 Duration & Negative Conv exity Callables (1-5 Years) Duration Years) (1-5 Callables Nov-05 Convexity Negative - Apr-06 5 Year US US 5 Year BulletAgency Index Sep -0 6 Feb -0 7 Jul-07 Dec-07 duration. May-08 Oct-08 Mar-09 Aug-09 Jan-10 5 5 Year Treasury Yield Jun-10 Nov-10 Apr-11 Sep -1 1 Feb -1 2 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep -1 6 Feb -1 7 0 1 2 3 4 5 6 7 9 Source: Bloomberg 101 103 105 107 109 95 97 99 BAML 1 they were they were issued at On average, callable portfolios Jun-00 Oct-00 - 5 Year US Non Feb-01 Price Upside? Jun-01 Oct-01 Feb-02 Jun-02 - Oct-02 Bullet Agency Index & BAML 1 Feb-03 Jun-03 Oct-03 Feb-04 par. Jun-04 Oct-04 Feb-05 Jun-05 Oct-05 Bullets (1 -5 Year) Feb-06 Jun-06 were carried loss $0.12 a were at vs $3.20 a - 5 Year US US 5 Year BulletAgency Index Oct-06 Feb-07 Jun-07 Oct-07 Upside Price Feb-08 Jun-08 Callables (1-5 Years) (1-5 Callables Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 $103.20 Price Average Jun-11 Par Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 gain, Jun-14 Oct-14 $99.88 Price Average Feb-15 Jun-15 assuming assuming Oct-15 Feb-16 Jun-16 Oct-16 Feb-17 10 Total Return Attribution Breaks down an assets return into individual components (i.e. factors) Done via regression analysis Currency, country, yield curve, spread, etc. Sum up the component return to create total return number In this case, we break down the returns of bullets and callables into two different factors CURVE CARRY – Includes (Accrued Interest + Roll Down) CURVE CHANGE – Returns attributed to parallel shift in the yield curve (up or down) 11 Total Return Attribution Curve Carry (Accrued + Roll Down) Curve Change Bullets Callable Delta Bullets Callable Delta Mar-13 0.09% 0.07% 0.02% -0.03% -0.04% 0.01% Jun-13 0.09% 0.08% 0.01% -0.86% -0.75% -0.11% Sep-13 0.15% 0.15% 0.00% 0.06% 0.03% 0.03% Dec-13 0.13% 0.12% 0.01% -0.41% -0.40% -0.01% Mar-14 0.14% 0.13% 0.01% -0.15% -0.12% -0.03% Jun-14 0.16% 0.15% 0.01% 0.04% 0.03% 0.01% Sep-14 0.17% 0.17% 0.00% -0.31% -0.37% 0.06% Dec-14 0.17% 0.16% 0.01% -0.11% -0.34% 0.23% Mar-15 0.17% 0.11% 0.06% 0.43% -0.06% 0.49% Jun-15 0.17% 0.11% 0.06% -0.30% -0.14% -0.16% Sep-15 0.19% 0.13% 0.06% 0.16% 0.16% 0.00% Dec-15 0.21% 0.16% 0.05% -0.84% -0.47% -0.37% Mar-16 0.21% 0.17% 0.04% 0.78% 0.37% 0.41% Jun-16 0.19% 0.14% 0.05% 0.44% 0.07% 0.37% Sep-16 0.18% 0.14% 0.04% -0.41% -0.15% -0.26% Dec-16 0.26% 0.22% 0.04% -1.26% -0.83% -0.43% Sum 2.68% 2.21% 0.47% -2.77% -3.01% 0.24% Callables offer inferior returns to bullets on both factors. Source: Bloomberg BAML 1-5 Year US Non-Bullet Agency Index & BAML 1-5 Year US Bullet Agency Index 12 Callables – From Issuer’s Perspective Bullet Yield Curve Hypothetical Callable Coupon Bullet Coupon Price Year Bullet Rate Callable Rate Term Structure Coupon Price Cashflow 5.00% $ 500,000.00 $ 100.00 Year 1 1.00% 1.50% 1.50% $ 550,000.00 $ 100.00 5.00% $ 500,000.00 $ 102.80 Year 2 2.00% 2.50% 2.50% $ 450,000.00 $ 100.00 5.00% $ 500,000.00 $ 103.85 Year 3 3.00% 3.50% 3.50% $ 350,000.00 $ 100.00 5.00% $ 500,000.00 $ 102.96 Year 4 4.00% 4.50% 4.50% $ 250,000.00 $ 100.00 5.00% $ 500,000.00 $ 100.00 Year 5 5.00% 5.50% 5.50% $ 150,000.00 $ 100.00 Total $ 2,500,000.00 Total $ 1,750,000.00 Issuing a callable saves a $750,000 in coupon payments over the life of the bond 13 Hypothetical Case (Fixed vs Step-up Callable) Fixed Coupon Callable Fixed Coupon Callable Price Bullet Equivalent Coupon Price Delta Rate With Cap Price Cashflow 5.50% $ 100.00 $ 101.79 $ 1.79 $ 550,000.00 5.50% $ 100.00 $ 104.20 $ 4.20 $ 550,000.00 5.50% $ 100.00 $ 104.82 $ 4.82 $ 550,000.00 5.50% $ 100.00 $ 103.45 $ 3.45 $ 550,000.00 5.50% $ 100.00 $ 100.00 $ - $ 550,000.00 Total $ 2,750,000.00 Fixed Coupon Callable Step-up cash flow catches up with Fixed Callable in the final provides higher cash year.