Question #42

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

Page: 17

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Part of Context Group: Q42-44 First in Group
Shared Context
- What is the value of the capped floater using Nagy's line manager's binomial tree of interest rate expectations? A) $98.80. B) $99.26. C) $101.44. Explanation Value at T2 Upper = $106.5 / 1.09892 = $96.91 (Note coupon capped at $6.50.) Middle = $106 / 1.06 = $100 Lower = $103.639 / 1.03639 = $100 Value at T1 Upper = ½($103.41 + $106.50) / 1.07704 = $97.45 (Note coupon capped at $6.) Lower = ½($104.63 + $104.63) / 1.04673 = $100 Value at T0 Price = ½($103.45 + $106) / 1.06 = $98.80 (Module 27.7, LOS 27.m)
Question
Which of the following statements is/are correct? Statement I: The straight bond should trade for less than $102. Statement II: If interest rate volatility were to increase then the price differential between the two Redna bonds would widen.
Answer Choices:
A. Both statements are correct
B. Statement I is correct but Statement II is incorrect
C. Statement I is incorrect but Statement II is correct. Explanation The straight bond will be priced higher, as the investor will not have the risk of the bond being called. If interest rate volatility rises then the call option will become more valuable, and the price differential will widen. (Module 27.1, LOS 27.b)
No explanation available for this question.
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