CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

Two bonds issued by the same corporation have identical coupon rate, payment frequencies, par values and time to maturity. The indenture of the first bond contains a call option, and the indenture of the second bond specifies a conversion privilege.
A. The value of the first bond is greater than or equal to the value of the second bond.
B. The value of the first bond is less than the value of the second bond.
C. There is not enough information to determine the comparative valuation.
Explanation: Because the promised cash flows are identical, the value of the bonds would be the same except for the impact of the embedded options. The call option, because it is an option that the bond issuer can exercise, reduces the value of the bond. The conversion option, because it is an option that the bond owner can exercise, increases the value of the bond.

User Contributed Comments 5

User Comment
kclau Given that call option reduces the value and conversion option increases the value of the bond, how do we know for sure the net off effect on the price of the bond? Shouldn't the answer be the last one?
PedroEdmundo do not forget that the "value of the bond" mean the "option-free price". In other words, the call option reduce the option free price(bond price= option free price - call option) and the conversion option increase the option free price (bond price= option free price + conversion value)
cahiz84 Less value = higher required yield
shahzeb What about collateral? What if the first bond is secured and the second is unsecured? The question does not state that and so one would pick C. Thoughts?
njhpeyton What about liquidity and collateral? I thought the correct answer here should be "C".
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