Confirmation of interest rate volatility vs. changes therefore, directly, into, interest

rohitdoshi

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.

giants2010

1. Correct
2. Correct
3. Correct

SpyAli

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!

profil

Yes, missed out on Vcall in the 3rd point. Vcall will go up. Totally agree with david.

bbtomato

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.

yalo

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)

defour44

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.

kkn006

VCallableBond=VNonCallAbleBond - VCall.

Interest Rate increase - VNonCallableBond decreases.
VCall Increases (as above)

so VCallableBond decreases

VPutableBond = VNonPutableBond + VPut

VNonPutableBond decreases
VPut Decreases as well.

So VPutableBond decreases.

CP

tarunajwani

CPK--

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?

MiniMe7

Yes,

Vbond = Vnoncallable - Vcall ... that is what I meant.

I agree Vcall should increase due to an increase in Int rates.