Question

Use the following information for questions 6-11. A BB+ rated firm (0.8., a high yield or non-investment grade) has issued a callable bond with the following features: • Exactly 2 years to maturity • 9% annual coupon • $100 par value • The bond is callable in exactly one year for par value. 6. Relative to a non-callable bond with identical features, the price of the callable bond will be a. Lower, because the buyer of the bond is also "long" the call option which makes the bond less valuable for its buyer. b. Lower, because the buyer of the bond is also "short" the call option which makes the bond less valuable for its buyer. c. Higher, because the issuer of the bond is also "long the call option which makes it more valuable to the buyer. d. Higher, because the issuer of the bond is also "short" the call option which makes it more valuable to the buyer. e. Equal, because the call option is worthless. 7. High yield, or non-investment grade, rated firms are likely to issue callable bonds than are investment grade firms because a. Less; they expect their credit ratings to continue to fall making the option worthless b. Less, they expect their credit ratings to improve making the call option less valuable c. More their credit ratings have more room to improve making it more likely they are able to exercise the call option d. More their bond prices are more likely to fall making the call option more valuable to them e. Equally, there is simply no difference in these two types of firms so there will be no difference in their likelihood of issuing callable bonds. MacBook Pro

Answer 1

6) B , callable bonds can be called off anytime by issuer(specially when yield decreases and price increases).This creates short position for the investor.

7)C , Non-investment grade issues more callable bonds, as bond price will increase there are more chances to call back the bond

9)B , A callable bond is made up of a straight bond and a written call option. An increase in volatility increases the value of the call option and decreases the value of the callable bond.