Question #93

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: 41

Status: Unattempted

Part of Context Group: Q93-94 First in Group
Shared Context
- Wall is a little confused over the relationship between the embedded option and the callable bond. How does the value of the embedded call option change when interest rate volatility increases? The value: A) may increase or decrease. B) increases. C) decreases. Explanation All option values increase when the volatility of the underlying asset increases. (Module 27.2, LOS 27.f)
Question
Wall wonders how the value of the callable bond changes when interest rate volatility increases. How will an increase in volatility affect the value of the callable bond? The value:
Answer Choices:
A. may increase or decrease
B. decreases
C. increases. Explanation The value of the callable bond decreases if the interest rate volatility increases because the value of the embedded call option increases. Since the value of the callable bond is the difference between the value of the non-callable bond and the value of the embedded call option, its value has to decrease. (Module 27.2, LOS 27.f)
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