Hey guys, just a quick question re: effects on the value of a bond due to interest rate or stock volatility changes. I’m doing Scheweser practice exam vol1 exam1 afternoon session question 114. Basically there are two bonds:
Convertible with call and,
Non convertible with putable option.
Expected changes are:decreasing volatility in the price of the company common stock and increasing volatility in the level of interest rates. What would be the combined effect on the two bonds?
I know the effect of a decreased stock price volatility is a decrease in value of the call on the stock. An increase in interest rate volatility would result in higher values for the call and put options. The question I have is: would the straight value of the bond change as a result of the increase in interest rate volatility? The answer only addressed the effects on the value of the options. Thanks.
The interest rates have a very little effect on convertible prices. The main drivers on the value of a convertible bond are the stock price, stock volatility, and credit spread. See the paper: Is the diffusion model a good solution for credit risk modeling? the case of convertible bonds. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2273296