On a given day, a bond with a call provision rose in value by 1%. What can be said about the level and volatility of interest rates? A) The only possible explanation is that level of interest rates fell. B) A possibility is that the level of interest rates remained constant, but the volatility of interest rates rose. C) A possibility is that the level of interest rates remained constant, but the volatility of interest rates fell.
C
Agree. C.
Value of Callable bond = Value of Straight bond - Call Option LHS rose by 1% Two possible explanations: --> Level of Interest rates rose --> Volatality decreased making call option less valuable So I agree with Answer ©
C. remember, the call option on the bond hurts the bond holder and therefore drags down the price of the bond. If the value of the option goes down, that increases the value of the bond. Option values go down when interest rate volatility goes down.
Pretty easy… Callable Bond = Option Free Bond - Call Value CB = OFB - CV CB UP by 1% when the level of IR = constant (so OFB = constant) and hence for the equation to match CV must go down. CV goes down when IRV goes down. Gotta be C on this one.
Using DIVUTS and DUUUUD for Call Option When V Up (Volatility Up) Call Option Up. Both move in same direction. So B gets ruled out - because if interest rate volatility rose - C would go up, so P(CB) would go down. Interest Rate falls - that is the I in DIVUTS - P(NCB) rise, C falls - so overall effect would be more in terms of P(CB) falling. A is ruled out. So answer is C.
The correct answer was C) A possibility is that the level of interest rates remained constant, but the volatility of interest rates fell. As volatility declines, so will the option value, which means the value of a callable bond will rise. Yes, the answer is C…I forgot the formula… Callable Bond = Option Free Bond - Call Value Thank you guys!
cpk123 Wrote: ------------------------------------------------------- > Using DIVUTS and DUUUUD for Call Option > When V Up (Volatility Up) Call Option Up. Both > move in same direction. cpk, d=dividends i=interest rates v=volatility u=underlying t=time s= ‘share’ price? i think i’m just hitting the wall… what does divuts & duuud stand for?
DIVUTS is a mnemonic for remember various parts of the Option change stuff. D=Dividend I=Interest Rate V=Volatility U=Underlying Price T=Time to Expiration S=Strike Price How do these affect a Call Option? DUUUUD When Dividends is UP - Call Option goes DOWN D Interest Rate Up - Call option UP U Volatility UP - Call UP U Underlying UP - Call UP U Time to Expiration UP - Call UP Strike Price UP - Call DOWN D So DUUUUD Put it is UDUDUU
nice. it’s on the first page of book 6. 
thanks for the explanation.