Question #23

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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Part of Context Group: Q23-25 First in Group
Shared Context
- Using the binomial tree model, what is the value of the callable bond? A) $101.735. B) $95.521. C) $102.196. Explanation The value of this bond at node 0 is V0 = ½ × [($99.391 + $7) ÷ 1.048755 + ($100.000 + $7) ÷ 1.048755] = $101.735, so the price of the callable bond is $101.735. (Module 27.2, LOS 27.f)
Question
What is the value of the call option embedded in this bond?
Answer Choices:
A. $6.675
B. $0.461
C. $12.924. Explanation Given in the problem is the value of the bond's option-free counterpart: $102.196. From Part A we've determined the price of the callable bond to be $101.735. From the relationship: Vcall = Voption-free – Vcallable We can determine that the value of the call option is $102.196 – $101.735 = $0.461. (Module 27.2, LOS 27.f)
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