In addition, forecasts on the fundamental health of the economy can be of value in developing predictions for future interest rate volatility. As these figures illustrate, measured over a short period of time such as one year, interest rate volatility rises and falls considerably. As the time period lengthens, interest rate volatility varies proportionately less and the volatility curve becomes flatter. Since the length of the option embedded in Fannie Mae callable debt is typically one year or longer, investors should find it most useful to consider volatilities measured over longer rather than shorter periods of time. It may be unreasonable, however, to expect such periods to be sustained, so investors may choose to exclude that period from consideration or, at least, to consider volatilities measured over longer time segments that smooth out such temporary phenomena.
Historical volatilities can provide a useful context for determining future volatilities.
The initial pricing and future returns of Fannie Mae callable debt are determined in large part by the initial yield curve and changes in the yield curve over time. As discussed previously, the key points on the yield curve that affect callable debt are those corresponding to a security's call and maturity dates. In the analysis that follows, we assume that the implied volatility of interest rates at which callables are priced does not change. The nominal spread of a 5nc2 callable debt security over the 5-year U.S. Treasury yield increases and declines for two main reasons. The value of the 5nc2 callable debt security is equal to the value of the 5-year bullet minus the value of the call option.