In Reading 37 Schweser states that Straight bonds are unaffected by interest rate volatility. However suppose I am valuing a straight bond using a binomial interest rate tree. The adjacent 2 interest rates are 2 standard deviations apart. I value a bond with a assumed volatility estimate for the forward rates. Suppose I increase the volatility estimate there then the distance between high and low values of the forward rates will increase so will the value of the bond after increasing the volatility change? If it does,doesnt this contradict what Schweser states in the next reading?
All bonds are affected by interest rates.
However, interest rate volatility in binomial trees does not affect straight bonds value because the tree is symmetrical. This means that if you increase the IR volatility the tree will widen up and down at the same amount cancelling the effect. Remember that volatility means higher standard deviation of something, and that the deviations are equally distributed up and down the mean.
In the case of option-embedded bonds, the options inside the bond do depend from volatility.
Remember that an option-embedded bond value is the summation of a straight bond value and the options value. So:
Callable & putable bond value = straight bond value + call value - put value.
The higher the volatility, the higher the call value and the higher the put value, however the straight bond value is the same.
Hope this helps.