“Higher discount rates imply lower present values, and thus the value of a risky bond will be lower than that of an otherwise identical default-free bond” Pg :142
Shouldn’t the value of Call option decrease with increase in risk (option value)
Value of bond = Value of Straight bond - Value of Call option
And value of put bond increase
Value of bond = Value of Straight bond + Value of put option
So, why are they suggesting to increase the discount rate for both? What am i missing?
An investor demands a higher return from a riskier asset (all else equal), which would also mean a decrease in the straight bond value, which, I think, likely outweighs any impact of risk on value of the call option.
A little tricky to interpret based on the extract you have included (I don’t have the printed tet to check), but is it possible that this statement is referring to bonds without embedded options? It is logical to expect that in the case of option-free bonds the value of a risky bond will be lower than the value of an otherwise identical default-free bond.