An 8 year bond is trading at par and is callable in 4 years at 101. If there is an unexpected decrease in interest rate volatility, the value of the bond should (all else being equal): A. increase B. decrease C. remain unchanged D. go to zero
A
why would the bond increase? Isn’t a decrease in rate volatility (be definition) equal to an increase in rates? just me asking
I would go with A also
less risk, hence worth more. lol. that’s the way i look. although i am sure there is a better explaination if my answer is right.
Because at volatility decrease the price of the embedded call option decreases.
option cost increases with increased rate volatility. a call option on a bond is a negative for the holder of the bond, so with less volatility in rates, the option is worth less and the bond becomes more attractive and higher in value.
the answer is A “a decrease in rate volatility makes the bond less likely to be called away by the issuer” Let me get this straight: bond yields are going higher (decrease in rate volatility) and the price of bond goes UP? why? Isn’t the cardinal rule of bonds that prices and yield move in opposite directions…
volatility does not have anything to do with the direction of rates
Increased volatility means increased instability, more up and down swings of the interest rate, not only in one way.
yancey i’d suggest read pg 284 of the book 5 very carefully. book explains it the best. just 2 paragraphs and 1 point on exam. I am sitting with 6 books and about 2000 pages of notes. reading left and right, notthing is making sense.
decrease in volatility makes the price of the option less, which makes the VALUE of the bond increase. A-HA thanks
value of callable bond = value of bond - value of the call. the value of a call and a put both increase in times of interest rate volatility thus, if the value of the embedded call decreases, the value of the bond must increase.