Because a higher interest rate scenario limits the probability of the call option being in the money, the value of a call option will be lower for an upward sloping yield curve.
Anyone can explain this for me? Many thanks.
I can’t, but I’d look at the components of the BSM and see if the answer is in there.
My understanding is: A higher interest rate (risk free rate) decreases the value of discounted exercise price, therefore INCREASING (not decreasing) the probability of call option being IN the money. Therefore the value of call option will be higher (not lower) Correct me if i’m wrong.
Why do you think this?
It’s in schweser note Magician.
Are we talking about a call option embedded in a bond?
Yes. It took me a lot of time reading Scheweser note but I cant explain how changes in the shape of the yield curve affect the value of callable bond or putable bond.
when interest rates rise - price of bond falls.
If you bought the call option - you expect the price of the underlying to increase. Here the underlying is falling in price. So there is less chance of the call option being exercised.
Does that make sense??
Many thanks CPK. It much helped.