Valuation and Analysis of Bonds with Embedded Options

Correct Answer: The value of the bond will be higher than a similar bond without the put option, as the put option provides the bondholder with additional protection against interest rate risk.

The correct answer is that the value of the bond will be higher than a similar bond without the put option. The put option provides the bondholder with additional protection against interest rate risk by allowing them to sell the bond back to GHI Corporation at a predetermined price of $1,025 on the 12th anniversary of the issue date. If interest rates rise significantly above the coupon rate of 6%, the bondholder can exercise the put option and sell the bond back at a higher price than its market value, thereby limiting their potential losses. This embedded put option makes the bond more valuable compared to a similar bond without such an option. The other two statements are incorrect because: - The put option does not introduce additional uncertainty for the bondholder; instead, it provides them with more certainty by offering a predetermined sell-back price. - The embedded put option does have an impact on the bond's valuation, as it offers additional value to the bondholder in the form of protection against interest rate risk.

Correct Answer: The value of the bond with the put option will be higher than an otherwise identical bond without the put option, as the embedded option provides additional protection to the bondholder.

The correct answer is that the value of the bond with the put option will be higher than an otherwise identical bond without the put option. The put option provides the bondholder with additional protection by allowing them to sell the bond back to XYZ Corporation at par value on the 5th anniversary of the issue date. This embedded option reduces the risk for the bondholder, as they can choose to sell the bond if market interest rates rise significantly above the bond's coupon rate. As a result, the bond with the put option will be more attractive to investors compared to a similar bond without the put option. Investors are willing to pay a premium for this additional protection, which increases the value of the bond with the put option relative to the bond without it. The other two statements are incorrect because: - The issuer does not have the right to redeem the bond early; it is the bondholder who has the right to sell the bond back to the issuer. - The embedded put option does have a significant impact on the bond's value, as it provides additional protection and flexibility to the bondholder, making the bond more attractive and valuable compared to a bond without the put option.

Correct Answer: The value of JKL Corporation's callable bond will be lower than the value of a similar non-callable bond due to the presence of the call option.

The correct answer is that the value of JKL Corporation's callable bond will be lower than the value of a similar non-callable bond due to the presence of the call option. The embedded call option gives JKL Corporation the right to redeem the bond at a price of $1,100 on or after the 15th anniversary of the issue date. This call option is valuable to the issuer because it allows them to retire the debt early if market interest rates decline, which would make the existing bond less attractive. From an investor's perspective, the call option is a disadvantage because it introduces the risk that the bond will be redeemed prior to maturity, forcing the investor to reinvest the proceeds at a potentially lower interest rate. As a result, investors will demand a higher yield (lower price) for a callable bond compared to a non-callable bond with similar characteristics to compensate for this additional risk. The other two options are incorrect because they either state that the callable bond will have a higher value than a non-callable bond or that the call option has no impact on the bond's valuation, both of which are not accurate given the disadvantage the call option presents to investors.