- CFA Exams
- CFA Exam: Level II 2021
- Study Session 13. Fixed Income (2)
- Reading 34. Valuation and Analysis of Bonds with Embedded Options
- Subject 3. Valuation of Default-Free Callable and Putable Bonds

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**CFA Practice Question**

A straight bond is priced at $102.5. An embedded call option is priced at $4, given an interest rate volatility of 15%. If interest rate volatility goes up to be 20%, an otherwise identical bond but with such an embedded call option will MOST LIKELY be priced at:

B. $98.5

C. $105.5

A. $97.5

B. $98.5

C. $105.5

Correct Answer: A

The price of the callable bond will likely decrease as the interest rate volatility goes up. With interest rate volatility of 15% the price is 102.5 - 4 = 98.5. The price has to be lower than 98.5 if the interest rate volatility becomes 20%.

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