AuthorTopic: Fixed Income lvl II question
@2009-11-19 10:27:09
Well, to be specific, the question concerns volatility of interest rates.

It is said, that value of an option-free bond doesn`t depend on the volatility of interest rates (this is one of the arguments to state that callable bond loses in value when volatility goes up).

Well, how can this be? Isn't volatility a measure of interest rate risk (in pair with duration)?

Maybe I am taking this too simply...
@2009-11-22 10:46:53
It is simple. Volatility is an input into the value of an option. A callable bond is an bond + call option. Volatility is not an input into the value of a vanilla bond. Yes, maybe a lower credit rating bond will be more volatile, but that is a function of the larger risk premium, and has nothing to do with vol so to speak in the way you are referring to it.

Duration measures reaction to changes in interest rates. Implied volatility (the input to an option's value) is derived from expected bond price variance ...

CFA Discussion Topic: Fixed Income lvl II question

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