Reading 61: Risks Associated with Investing in Bonds- LO

following, option, similar, percent, studying

LOS d: Identify the relationship among the price of a callable bond, the price of an option-free bond, and the price of an embedded call option.

Q1. Jori England, CFA candidate, is studying the value of callable bonds. She has the following information: a callable bond with a call option value calculated at 1.75 (prices are quoted as a percent of par) and a straight bond similar in all other aspects priced at 98.0. Which of the following choices is closest to what England calculates as the value for the callable bond?

A) 99.75.

B) 96.25.

C) 98.75.

Q2. Which of the following statements about the relationship between the value of a callable bond, the value of an option-free bond, and the value of the embedded call option is TRUE?

A) Value of a callable bond = value of an option-free bond ? value of an embedded call option.

B) Value of a callable bond = present value of the interest payments + present value of the principal at maturity.

C) Value of a callable bond = value of an option-free bond + value of an embedded call option.

Q3. As part of his job at an investment banking firm, Damian O’Connor, CFA, needs to calculate the value of bonds that contain a call option. Today, he must value a 10-year, 7.5% annual coupon bond callable in five years priced at 96.5 (prices are stated as a percentage of par). A straight bond that is similar in all other aspects as the callable bond is priced at 99.0. Which of the following is closest to the value of the call option?

A) 2.5.

B) 4.2.

C) 3.5.

Q4. If the volatility of interest rates increases, which of the following will experience the smallest price increase resulting from lower rates?

A) Putable bond.

B) Zero-coupon option-free bond.

C) Callable bond.

Q5. When market rates were 6% an analyst observed a $1,000 par value callable bond selling for $950. At the same time the analyst also observed an identical non-callable bond selling for $980. What would the analyst estimate the value of the call option on the callable bond to be worth?

A) $20.

B) $80.

C) $30.

Q6. Which of the following statements about the value of a callable bond is FALSE?

A) The value of the callable bond is less than the value of an option-free bond in an amount equal to the value of the call option.

B) The value of a callable bond equals the value of the bond without the option plus the option value.

C) When yields rise, the value of a callable bond may exhibit less of a price change than a noncallable bond.

Q7. Which of the following statements about a callable bond is TRUE?

A) A bondholder usually loses if a bond is called by being forced to reinvest the proceeds at a lower interest rate.

B) Callable bonds follow the standard inverse relationship between interest rates and price.

C) The call option on a bond trades separately from the bond itself.