Brady bond price when only US yields rise
Question
A 30-year Mexican Brady bond pays an coupon. Suppose US interest rates rise by one percentage point while Mexican rates do not move. What happens to the Brady bond's price, and why?
Short answer
It falls. A Brady bond's principal is collateralised by long US Treasury zero-coupon bonds (and part of its interest is often guaranteed too). The guaranteed pieces are valued off US yields, so a rise in US rates cuts their value sharply (a 30-year zero loses roughly a quarter of its value), dragging the bond's price down even though the Mexican sovereign spread is unchanged.
Adapted from Crack, Heard on the Street, Q3.14, p.35; question and answer rewritten by SelfMadeQuant.com.
See the hint and the full worked solution in the question bank (free account).
Open the worked solution