- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 30. Valuation and Analysis of Bonds with Embedded Options
- Subject 2. Relationships between the Values of a Callable or Putable Bond, Straight Bond, and Embedded Option

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**CFA Practice Question**

The option costs are ______ when the investor has ______ an option, and the costs are ______ when the investor has ______ an option.

B. positive; holds; negative; written

C. negative; bought; positive; sold

A. positive; bought; negative; sold

B. positive; holds; negative; written

C. negative; bought; positive; sold

Correct Answer: C

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**User Contributed Comments**
12

User |
Comment |
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chenyx |
Z-spread = OAS + option cost. callable option-->investor sold option-->option cost > 0 putable option-->investor bought option-->option cost < 0 |

tkorchmaros |
if you buy an option, it will always cost you. Maybe it would make sense to formulate it this way: The option cost is negative when the investor has bought a callable bond... |

ljamieson |
Yeah, going with the theory that a long option has positive value pretty much contradicts this answer. When you buy a callable bond you are short an option. |

SaeedAlam |
Option cost is + when detrimental to bondholder |

thammy |
Note option cost in this definition is measured in terms of spread (ie z-spread - OAS), not the bond price. If bondholder bought the option, then this so-defined "option cost" is negative. |

Kashi2010 |
Concept is important: - If an investor buys a bond where they have a PUT option, then the bond price will be higher (lower risk, lower yield) - If an investor buys a bond where the issuer has a CALL option, then the bond price will be lower (higher risk, higher yield). |

jpducros |
When we talk about Price: Price Callable Bond = Price non-callable Bond - Call Option Price Putable Bond = Price non-putable Bond + Put Option Attention when we talk about Yield: z-spread = OAS + Option Cost Option Cost is + for Call and - for Put |

VenkatB |
From the investor's point of view... Value of Callable Bond = Value of Option-free Bond - Value of Call Option Value of Putable Bond = Value of Option-free Bond + Value of Put Option. Here the terms "Value of Call Option" and "Value of put Option" refer to Option cost.. So value of put option (option cost of put option) = Value of Putable Bond - Value of Option-free Bond This will be negative as putable bond value is always less than option free bond.. So when the investor bought the option, option cost is negative |

NIKKIZ |
What a question! A negative cost in my mind makes a positive ( as a cost is negative in itself). With that logic, I went for B which, if costs are interpreted as being negative from the start, would be correct. |

bbadger |
I trade options. It takes a simple concept. When you own an option, you have a right to do something. You pay for that right. Callable bonds give the seller the right to call the bond. That's good for him. He pays for that right = the bond price is lower. Same with a putable bond. The investor gets a right to sell the bond. He pays for that right = the bond price is higher. |

Stoibayev |
The cost is already negative or already implies an outflow.....Two negatives make positive... Why bother to say cost is negative when we purchase an option... The |

davidt876 |
NIKKIZ you were right to begin with but somehow confused yourself. the option cost is subtracted from the price. so if the option cost is negative, you subtract that negative and therefore it has a positive impact, and increases the price. cost is negative when you buy an option = you pay more for the option |