^^^ call options never benefit the investor.
budfox427 Wrote: ------------------------------------------------------- > ^^^ > > call options never benefit the investor. but if interest rates go way up, you don’t have to worry about a call. therefore if the call option was worth $5, then that value will have disappeared and the bond will go down $5 less… basically a smaller negative now. bond goes from 100 - 5 to 75 - 0… bond went down $20. without call option, bond would have gone down $25… but i think that’s reading far too much into what they’re asking. but with CFA, you never know.
What the heck is going on here? There are high school drop outs on bond trading desks who understand this concept intuitively in about half a second. Anyone who introduces a greek letter or any three syllable finance concept in order to figure this out should be taken out back and have his / her head examined. If interest rates rise, you don’t want to “call” a bond (because you’d have to refinance the debt at a higher rate). So the value of the call option decreases. I know other people have said the same thing by now, but I just wanted to share my astonishment at how absolutely convoluted some people made this. (that and I really don’t feel like studying right now).
Olivier, this is true for stand-alone options, but the question is asking the valuation of an embedded option in context of a callable bond. olivier Wrote: ------------------------------------------------------- > A) > > Increase in interest rates make an option more > valuable since the buyer of the option (the bond > issuer in this case) doesn’t have to put the full > value of the exercise price up front. > > The value of the call option increases.
Yes, I realize that now, the impact on the underlying is likely much bigger that the impact I described. Hence, I will go with C) I hope that I won’t make stupid mistakes like that on the exam
plyon Wrote: ------------------------------------------------------- > What the heck is going on here? There are high > school drop outs on bond trading desks who > understand this concept intuitively in about half > a second. Anyone who introduces a greek letter or > any three syllable finance concept in order to > figure this out should be taken out back and have > his / her head examined. > > If interest rates rise, you don’t want to “call” > a bond (because you’d have to refinance the debt > at a higher rate). So the value of the call > option decreases. > > I know other people have said the same thing by > now, but I just wanted to share my astonishment at > how absolutely convoluted some people made this. > (that and I really don’t feel like studying right > now). First, I’ve never met a high school dropout on a bond trading desk. Second, I think the first person to use a greek letter (rho) was me and I did it just for fun when someone said something like “it’s a long term note and short rates drop but not long rates, then what happens to the option?” It’s a mildly interesting question and it’s about the key rate duration of a callable bond. I think those would be appropriate questions on LIII and just aren’t the stuff of high school dropouts. And furthermore - why are you being so cranky? I don’t want to get into the pot/kettle thing, but take a chill pill and relax. Edit: When you take someone out back you don’t examine their head.
JoeyDVivre Wrote: - > > First, I’ve never met a high school dropout on a > bond trading desk. > Absence of proof <> proof of absence. I’m sure they exist and appreciate this concept intuitively. Most likely my elusive person worked a Bear until recently. > Second, I think the first person to use a greek > letter (rho) was me and I did it just for fun I never know when you invoke greek letters for fun or not, but generally speaking when I see someone ask a question like this (it should be an easy question for a LII candidate), I’m for giving them the least amount of information possible in order to answer the question. I think that helps them pass the exam. > And furthermore - why are you being so cranky? I > don’t want to get into the pot/kettle thing, but > take a chill pill and relax. > Self evident. > Edit: When you take someone out back you don’t > examine their head. True… But I went back and softened my message up a bit just so I didn’t rub anyone the wrong way. My general point was that the concept is simple and should be kept simple in the candidate’s mind in order to maximize performance on exam day. Just my opinion.
I agree with that and I usually try to do my best on the pedagogy thing. On the other hand, this was “What happens to a bond call when interest rates go up?” question on AF LII…
Hello, I’m sure that it’s ©. The issuer of the bond owns the call option, and not the investor. The issuer can use the call option when the interest rates DECREASE (and prices increase). The value of the call option increases when rates decrease. The value of the call option decreases when rates increase. nicolargol Wrote: ------------------------------------------------------- > Hi, > > I had this question on QBank regarding callable > bonds and cannot figure out why I am wrong: > > > How does the value of the embedded call option > react to an increase in interest rates? > > A) increases > > B) remains the same > > C) decreases > > D) may increase or decrease > > > I chose D). Here are my 2cts: > > V callable = V option free - V Call option > > Rates increase, so both V callable and V option > free decrease. But what does prevent the > volatility to increase, leading to an increase in > V Call option? > > Thanks for telling me what is wrong.