Schweser Mock: please explain please, through, correct, interest, increase

vagabond

Questions 97 through 110 relate to Fixed Income.

If the volatility of interest rates increases, the prices of a putable bond and a callable bond will most likely:

Putable bond Callable bond



A) Increase Increase


B) Increase Decrease


C) Decrease Increase



Your answer: A was incorrect. The correct answer was B) Increase Decrease


In general, an increase in interest rate volatility increases the values of both put options and call options. A more valuable put option increases the price of a putable bond. A more valuable call option decreases the price of a callable bond.

smartpants

Thanks for this, I got this question wrong too and now it makes perfect sense.

lc26mizzou

You're both welcome.

Matori

Value of callable bond = Value of straight bond - Value of call option on the bond

Value of putable bond = Value of straight bond + Value of put option on the bond

An increase in interest rate volatility raises the value of the call and the put option. However, because the investor is short on the call option in the callable bond, the value of the callable bond falls.