Question #20
Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers
PDF File: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers.pdf
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Question
Which of the following statements about how interest rate volatility affects the value bond is most accurate? When interest rate volatility increases, the value of a:
Answer Choices:
A. callable bond decreases
B. putable bond decreases
C. straight bond decreases. Explanation Option values are positively related to the volatility of the underlying. Thus, when interest rate volatility increases, the values of both call and put options increase. When interest rate volatility increases, the value of a callable bond (where the investor is short the call option) decreases and the value of a putable bond (where the investor is long the put option) increases. The value of a straight bond is unaffected by changes in the volatility of interest rate, though value is affected by changes in the level of interest rate. (Module 27.3, LOS 27.d)
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