FixedIncomeRisk Forum

Question (this has been asked to many finance PhDs including professors): If a typical company issues either a callable bond, a straight bond, or a convertible bond, then which bond in general has the highest yield, and which bond has the lowest yield?

Answer (most PhDs and professors get it right): Callable has the highest yield and convertible has the lowest yield.

Question (this has been asked to many finance PhDs including professors): In the question above, which bond in general has the lowest expected return?

Answer (most PhDs and professors DO NOT get this right): The callable bond has the lowest expected return (despite having the highest yield), and the convertible bond has the highest expected return (despite having the lowest yield).

And this is as basic as it gets, since callable, straight, and convertible bonds have been around for a long time in our financial history.

Do you sometimes wonder like I do, exactly how were our MBA turned Hedge Fund analysts estimating "expected returns" when they were buying CDO-based hedge funds two years ago?

This makes sense intuitively when you think about it. Of course, I rarely heard talk of expected returns on bonds when I was in industry. It would make sense with convertibles. Of course most of the PMs I knew were income investors and yield ruled.

Now Bill Gross was an exception. His Total Return fund was truly that and they should have called it a risk-adjusted total return fund because he smoked everyone on a per standard deviation basis.