Reading 57: LOS j ～ Q10- 13

11．On a given day, a bond with a call provision rose in value by 1 percent. What can be said about the level and volatility of interest rates?

A)   A possibility is that the level of interest rates remained constant, but the volatility of interest rates rose.

B)   The only possible explanation is that level of interest rates fell.

C)   The only possible explanation is that level of interest rates fell and bond volatility rose.

D)   A possibility is that the level of interest rates remained constant, but the volatility of interest rates fell.

The correct answer was D)

As volatility declines, so will the option value, which means the value of a callable bond will rise.

12．As the volatility of interest rates increases, the value of a putable bond will:

A)   decline.

B)   remain constant.

C)   rise if the interest rate is below the coupon rate, and fall if the interest rate is above the coupon rate.

D)   rise.

The correct answer was D)

As volatility increases, so will the option value, which means the value of a putable bond will rise. Remember that with a putable bond, the investor is long the put option.

13．As the volatility of interest rates increases, the value of a callable bond will:

A)   rise.

B)   remain constant.

C)   rise if the interest rate is below the coupon rate, and fall if the interest rate is above the coupon rate.

D)   decline.

The correct answer was D)

As volatility increases, so will the option value, which means the value of a callable bond will decline. Remember that with a callable bond, the investor is short the call option.