Bond Q's

CFA Level I
#21

for a moment i got happy, now i back into know-nothing forget-everything mode.

#22

Why: bonds with options have less interest rate risk How do we know?

#23

Because think of options as ability of buyer/seller to hedge their risk with interest rate movements. hence options will lower your interest rate risk.

#24

pepp Wrote: ------------------------------------------------------- > Because think of options as ability of > buyer/seller to hedge their risk with interest > rate movements. hence options will lower your > interest rate risk. Thanks, but that can’t be the general answer.

#25

again, I dont reallyknow the real answers behind anything. I only know what makes common sense.

#26

thanks pepp

#27

okay, let’s try this one more time. Bonds with options are priced based on the formula that was given CB = OFB - call PB = OFB + Put Now if you increase int rate, OFB goes down Put goes up Call goes down Now if you decrease interest rate OFB goes up Put goes down Call goes up If you see the relationship among those calls, w/ the OFB, you’ll notice the change in OFB > change in call Hence, OFB moves more (up or down) compared to CB, PB

#28

If you own a bond yielding 4% and a bond yielding 6% that are both fixed for 10 yrs., is there more of a chance for interest rates to rise above the 4% or the 6%? Rates go up to 8% and you say, damn, I am stuck with these suckers or I take a hit if I sell them.

#29

thanks pepp, these are words that i understand.

#30

cfaisok Wrote: ------------------------------------------------------- > thanks pepp, these are words that i understand. heh, well remember instead of doing all that on that question, its easier to think, options reduce risk, or else whats the use of them. hence eliminate a and b withing 5 seconds.

#31

for the next question i will remember, although your statement about embedded options is generally not true…

#32

It is true. Have you ever seen a Option free bond selling for less price than an otherwise similar callable bond? Have you ever seen a Option free bond selling for more than the price of an otherwise similar puttable bond? As the time passes, youll prices of the two will converge. Thats what my common sense says.

#33

@pepp Ever heard of more complex options than standard puts and calls? In your world your statement is ok. In my world it’s not generally true.

#34

I will stop arguing with you pepp, because else I will get some bad critic from JoeyD.

#35

cfaisok Wrote: ------------------------------------------------------- > @pepp > > Ever heard of more complex options than standard > puts and calls? > In your world your statement is ok. > > In my world it’s not generally true. Ofcourse in real life i could always make loss do opposite of what theory says. But for CFA exam, is my understanding inadequate?

#36

in exam world you are completely right, but i am working and thinking in this outside world.

#37

cfaisok Wrote: ------------------------------------------------------- > I will stop arguing with you pepp, because else I > will get some bad critic from JoeyD. This is fine arguing, but what sort of embedded options are you thinking of in bonds besides calls and puts? There are conversion options but that’s an entirely different class of bonds (and conversion options are arbitrarily complicated).

#38

You can construct the bond with complex embedded options with differing strike/knockin and using some digital options, just to make the bondprice behave in another way. Are you really asking me, JoeyD - or is it a test?

#39

But the answers are no different if you change the strike on the options, make them binary, and/or use knock-ins…

#40

change long and short side, still not convinced?