Determining the call option value, Financial Management

The effective maturity of a callable bond can be anywhere between the first call date and its maturity date due to the presence of the call feature.

A callable bond is similar to an Option-free bond with a call option from the bondholder. Value of a callable bond is therefore the value of an option free bond minus the value of the call option.

Value of callable option  =      Value of an option-free bond - Value of a call option on the bond.

We have already seen the calculation of value for an option-free bond and the value of a callable bond. The difference between both the values will give the value of the call option. In our illustration, the value of the option-free bond is $100.714. If the call price is $99, each year and the value of the callable bond with an assumed volatility interest of 10% is $100.123, then value of the call option is $0.501.

Posted Date: 9/10/2012 7:03:02 AM | Location : United States

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