Interest rate, call option option

w1977

Im quoting QBank:

If interest rates fall, the:

A) value of call option embedded in the callable bond falls.
B) callable bond's price rises more slowly than that of a noncallable but otherwise identical bond.
C) callable bond's price rises faster than that of a noncallable but otherwise identical bond.

I answered B. correctly only because this is a fixed income question. But isn't A just as correct? As interest rates increase, call values rise, and vice versa.



Edited 1 time(s). Last edit at Sunday, October 25, 2009 at 10:53AM by nudge.

scr879

Call feature acts as a ceiling and will limit price appreciation when rates fall. I agree with revenant, it helps to draw out the graph.

JPSem

As rates fall the price of the bond rises up to a point (Call Price). The value of the call option actually increases once you pass the call price . The value of the option is the difference between the call price and the price of the non callable bond. Remember that the call is really of value to the issuer not the bondholder.

Say a no callable bond is at 110 a similar callable bond is 105. The issuer can call the bond and refinance the debt at the new lower rate......ummm I think LOL
been studying since 8:30 I'm fried