标题: Confirmation of interest rate volatility vs. changes [打印本页] 作者: rohitdoshi 时间: 2011-7-11 19:32 标题: Confirmation of interest rate volatility vs. changes
Hi guys,
I studied Reading 54 today and jotted down some very brief notes. I'd like to put it into my book but just want to ensure it's accurate (because it's based on my deductions rather then being directly stated). Can someone please confirm and let me know if all is correct? Thank you!
Interest rate VOLATILITY up = Vcall up, Vnoncallable unaffected, therefore Vcallable down
While NONcallable bonds are not affected by interest rate volatility, they ARE affected by interest rate changes (inverse relationship).
Therefore, as interest rates go up, Vcallable down, Vcall down, Vnoncallable down.作者: giants2010 时间: 2011-7-11 19:32
1. Correct
2. Correct
3. Kinda correct.
------> Interest rates go up, Value callable goes down (because bond prices are inversely related to interest rates AND the value of the call goes up which reduces the callable bond, so you got two things going here), Value call goes up (who owns the call? the issuing company), Value noncallable goes down.
Don't confuse with "volatility" of rates increasing and "interest rates" increasing. These are two different things, but can happen simultaneously.
Best in June!作者: profil 时间: 2011-7-11 19:32
Yes, missed out on Vcall in the 3rd point. Vcall will go up. Totally agree with david.作者: bbtomato 时间: 2011-7-11 19:32
okay i see what u are saying.
lets go back to put call parity to get value of call option.
C = P + S - X/ (1+r)
If interest rates go up, last component goes down and C goes up.
But with interest rates going up, S the spot price comes down(intrinsic characteristic of the underlying in this case). So, C goes down.
since these are contradicting effects, look like we cannot predict the value of embedded call option with interest rate movements then.作者: yalo 时间: 2011-7-11 19:32
interesting, lets have a look at this:
S = F / (1+r) , where F is forward price of a bond
when rates go up (parallel shift pls), forward price goes down.
rewrite the parity:
C = P + (F - X)/(1+r)
the difference is discounted by higher rate so the PV up, but F will be probably higher amount than the difference therefore the effect will be that it all goes down. On top of that time to expiry will be probably shorter than bond tenor from expiry time.
btw, P will go up (do not forget about put value) but the delta of put option is lower (in abs) than delta of S (or F)作者: defour44 时间: 2011-7-11 19:32
As the risk free rate increase the price of a call option increase. the price of a PUT option decreases.
the value of the bond would decrease:
Vbond = vnoncallable - vcallable
as vcallable increases, vbond decreases.
Am I off on this, I thought this was an area I had down pretty well so I think I'm right.作者: kkn006 时间: 2011-7-11 19:32
Your claim is the when rates increase, Vcallable and Vnoncallable decrease and Vcall increase.
The answer to the Schweser question says that Vcallable and Vnoncallable decrases, and Vcall decreases as well.
Are you saying they are wrong?作者: MiniMe7 时间: 2011-7-11 19:32
Yes,
Vbond = Vnoncallable - Vcall ... that is what I meant.
I agree Vcall should increase due to an increase in Int rates.作者: kickthatcfa 时间: 2011-7-11 19:32
bought callable bond is equal to bought straight bond and sold call option (sold right to buy the straight bond).
the value of the straight bond goes down when rates go up. therefore the value of the call bond option decreases.
or
the probability that the issuer exercises the option (calls the bond) goes down when rates go up. when probability of exercise goes down the value of option goes down
ok?作者: liquidity 时间: 2011-7-11 19:32
C=S+P-x/(1+r)
as r increases x decreases and C increases...
ok?作者: ayodayo 时间: 2011-7-11 19:32
and what happens with S in the formula? (it changes with rate change too!)
pls see my second post in this thread, I was explaining rate change effect on parity (of bond option) there.
Edited 1 time(s). Last edit at Monday, May 3, 2010 at 02:54PM by pfcfaataf.作者: Rasec 时间: 2011-7-11 19:32
Ok, so I found an "unofficial" answer to this:
For calls on Bonds the Delta drowns out the Rho effect - So pfcfaaf's reasoning is true.
The graph in the book is for equity securities, though it doesn't mention that in the book. In fact I don't remember reading anything on the differences b/w eq/bond options; does anyone have any reference to this in the CFAI texts? or would this not be tested? Iwould think that if there's a prectice Q like the one above it may be tested after all.
TenTen - BTW both answers are correct b/c for an equity call an increase in int rates would still increase the value of the equity call, however as was just posted with a rise in int rates the value of a call on a bond decreases.作者: troymo 时间: 2011-7-11 19:32
So the answers conflict?!
Derivatives section tells us that as rates increase, rho causes the value of the call (and put) to increase slightly.
Fixed Income section tells us that as rates increase, the Value of the callable bond decreases and consequently, the value of the call on that bond decreases. As Schweser says in their answer:
Since the underlying asset to the option (the bond) decreases in value the option must decrease in value also. (Study Session 14, LOS 54.e, f)
Can someone please make sense of this conflict?作者: bolligerallstar 时间: 2011-7-11 19:32
i dont have level 1 textbooks with me. what does it say about this?作者: bdavi77962 时间: 2011-7-11 19:32
rus1bus Wrote:
-------------------------------------------------------
> Level 1 does not say anything about Value of
> Embedded Call Option changing with Interest Rates.
> And i think, establishing a relationship between
> them is not relevant either.
>
> It only talks about Value of Embedded Call Option
> changing with Interest Rate Volatility.
it is part of LEVEL 1
see Level 1 CFAI book 5 page 24
"
...when int rates decline ... the price of call option ...increases because the call option becomes more valuable to the issuer.
similarly, when int rates rise,... the price of embedded call option declines."作者: sameeragarwal 时间: 2011-7-11 19:32
ataf, what you are quoting is value of free call option with interest rate changes. There is no argument on that, it will go down as interest rates go up.
What we are discussing is value of Embedded call option with interest rate changes.
Can you quote a relationship between value of Embedded call option with changes in Interest Rates in L1 text?作者: luda002 时间: 2011-7-11 19:32
I figured it out!
Peter Frampton, CFA @ Analyst Forum
oh yeah, I feel like you do!作者: tobeornottobe 时间: 2011-7-11 19:32
In the question, it is the embedded call that is referenced. The embedded call has an inverse relationship with rates.
Wall now turns his attention to the value of the embedded call option. How does the value of the embedded call option react to an increase in interest rates? The value of the embedded call:
A) decreases.
B) increases.
C) remains the same.
Your answer: A was correct!
Since the underlying asset to the option (the bond) decreases in value the option must decrease in value also. (Study Session 14, LOS 54.e, f)
Edited 1 time(s). Last edit at Tuesday, May 4, 2010 at 12:00PM by tenten.
