ajpheif16

Ruby's spot on... again

I am just going to make a minor tweak to her post below (in caps):


Ruby527 Wrote:
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> I may be wrong, but here's how I understand it:
>
> Firstly, volatility risk is the exposure to
> fluctuations in the market. In this case we are
> talking about changes in the interest rate. Stable
> economy==> lower volatility risk. Shaky
> economy==>higher volatility risk.
>
> The security in question has prepayment option,
> which implies that it carries a call option. A
> general rule is that the higher volatility in the
> market, the higher the value of your option
> (because there's greater probability it will be in
> the money). When you value a debt security with an
> embedded call option, you subtract the value of
> the option from the price of the bond with no
> embedded option. The question asks about a low
> volatility and that implies==>lower option
> value==>higher price of the BOND WITH THE EMBEDDED CALL/ PREPAYMENT OPTION. And we
> know that price of a bond and yield are inversely
> related, so the yield will decrease.
>
> I hope this helps.