CFA Practice Question

There are 252 practice questions for this study session.

CFA Practice Question

A 10-year, 8% coupon convertible bond, which is also callable, is currently trading at 97.50. An equivalent bond, which is completely free of any options, is currently trading at 94.62. If option models indicate that the value of the call on the stock is worth $9.25 per $100 par value of the bond, which of the following would then best estimate the value of call option on the bond?
A. $2.88 per $100 par value.
B. $6.37 per $100 par value.
C. $12.13 per $100 par value.
Explanation: 94.62 + 9.25 - 97.5 = 6.37 per $100 par value.

User Contributed Comments 6

User Comment
tim2 I don't get it. If the bond with no option is worth 97 and without is worth 94 then presumable the value of the option is the difference?
tim2 Ah.. I get it now... must read the questions properly!
ramdabom Shouldn't the option-free bond have a lower price (and hence higher yield) than the callable bond? Also, why is the call on the stock relevant here (i.e. why isn't it 97.5 - 94.62 = 2.88)?
Cesarnew ramdabom: cause the bond is convertible
daverco The price of a callable bond is always lower than an otherwise identical straight bond. Why then do we add the call-option value to the straight bond here? The calculation in the explanation would seem to make more sense if the $9.25 is the price of the conversion option.
birdperson here is the formula to spare you some time: value of callable convertible = straight value of bond + value of call option on stock - value of call option on bond, so......
Value of call on bond = straight value + value of call on stock - value of callable bond....
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