Volatility risk, Financial Management

Expected volatility is a major factor that affects the value of an option. Expected volatility of an option on bond is referred to as 'expected yield volatility'. The value of an option is directly related to the expected yield volatility. In other words, greater the expected yield volatility, greater would be the value of the option. Let us see how this works for a callable bond.

The price of a callable bond can be determined as follows:

Price of callable bond = Price of option-free bond - Price of embedded call option

Let us assume that all other factors except expected yield volatility are constant. Now if the expected yield volatility increases the price of the call option will also increase. Hence, the price of the callable bond would decrease.

In case of a putable bond, the price can be decomposed into the following two elements:

Price of putable bond = Price of option-free bond + Price of embedded option

A decrease in expected yield volatility would result in a decline in the price of the embedded put option. Therefore, the price of a putable bond would also decrease.

Volatility risk can be defined as the risk that the price of a bond with an embedded option will decrease when expected yield volatility changes.

Posted Date: 9/10/2012 1:29:57 AM | Location : United States







Related Discussions:- Volatility risk, Assignment Help, Ask Question on Volatility risk, Get Answer, Expert's Help, Volatility risk Discussions

Write discussion on Volatility risk
Your posts are moderated
Related Questions
Common Size Financial Statement Common Size Financial Statement is a company financial statement that shows all items as percentages of a common base figure. This kind of finan

Q. What do you mean by Treasury Bills? Treasury bills (TBs) are short-term government securities. The usual practice in India is to sell treasury bills at a discount and redeem

Explain how the special drawing rights (SDR) is constructed. Also, discuss the circumstances under which the SDR was created. Answer:   SDR was made by the IMF in 1970 as a new r

Why would it be useful to examine a country’s balance of payments data? Answer:  It would be helpful to observe a country’s BOP for at least two reasons. First, BOP offers detail

The Project to be Addressed by the Paper: You have just graduated from CCI's MBA program and have secured a position as a fund manager for a well known investment banking house

Managing Risk and Contingency Plan: An essential component of any financial management framework is the validation and protection of the information contained in the system. In

Financial Leverage In accounting and finance, the amount of long lasting debt that an organization has in relation to its equity the longer the ratio, the larger the lever

what is the applicability of the operating cycle in a vegetaion farm in Uganda

Functional Classification of Mutual Funds Functional classification of Mutual Funds is based on the basic characteristics of the mutual fund schemes for subscription. Mutual Fu

Q. What do you understand by Business cycle? Business cycle: business cycle refers to the alternate expansion and contraction in the general business activity. in a period of t