Question #64 - Reading 27 Valuation and Analysis of Bonds With Embedded Options

Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers

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Page: 27

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Shared Context

- Compute V0, the value of the bond at node 0. A) $104.76. B) $99.07. C) $101.35. Explanation V0 = (½)[(V1U + C) / (1 + r0)] + [(V1L + C) / (1 + r0)] From the previous question the value for V1U was determined to be $99.127 V0 = (½)[(99.127 + 8) / (1 + 0.043912)] + [(103.583 + 8)/(1 + 0.043912)] = $104.755 (Module 27.2, LOS 27.f)

Question

Assume that the bond is putable in one year at par ($100) and that the put will be exercised if the computed value is less than par. What is the value of the put option?

Answer Choices:

A. $0.42

B. $1.86

C. $3.70. Explanation Vputable = Vnonputable + Vput Rearranging, the value of the put can be stated as: Vput = Vputable − Vnonputable Vputable was computed to be $105.173 in the previous question, and Vnonputable was determined to be $104.755 in the question prior to that. So the value of the embedded put option for the bond under analysis is: $105.173 − 104.755 = $0.418 (Module 27.2, LOS 27.f)

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