Reading 55: Valuing Bonds with Embedded Options-LOS f~Q1-3 option, interest

youzizhang

 

LOS f: Explain the effect of volatility on the arbitrage-free value of an option.

Q1. As the volatility of interest rates increases, the value of a callable bond will:

A)   rise.

B)   rise if the interest rate is below the coupon rate, and fall if the interest rate is above the coupon rate.

C)   decline.

 

Q2. On a given day, a bond with a call provision rose in value by 1%. What can be said about the level and volatility of interest rates?

A)   The only possible explanation is that level of interest rates fell.

B)   A possibility is that the level of interest rates remained constant, but the volatility of interest rates rose.

C)   A possibility is that the level of interest rates remained constant, but the volatility of interest rates fell.

 

Q3. As the volatility of interest rates increases, the value of a putable bond will:

A)   rise.

B)   decline.

C)   rise if the interest rate is below the coupon rate, and fall if the interest rate is above the coupon rate.

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