Reading 54: Valuing Bonds with Embedded Options-LOS f 习题精 option, center, interest, face, 2010

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Session 14: Fixed Income: Valuation Concepts
Reading 54: Valuing Bonds with Embedded Options

LOS f: Explain the effect of volatility on the arbitrage-free value of an option.

 

 

 

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

A) decline.

B) rise.

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

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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.

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

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

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

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

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

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

A) decline.

B) rise.

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

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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.