Question 1

Which is more valuable and American call option or a European call op- tion?

Accepted Answer

The posiblity of exercising in more dates gives additional value to the holder. So an American call option is worth more than an European call option.

Question 2

Why is it that as the lockout period becomes longer the price of the bond increases?

Accepted Answer

This happens because an increase in the lockout increases restrictions on the option, which will fall in value. As the option reduces the value of the underlying bond, a fall in its price increases the value of the bond.

Question 3

What eﬀect does an embedded option have on a security's price?

Accepted Answer

An option is a security since it is a promise on contingent cash ﬂows. This means that, under no arbitrage, its price should be incorporated into the price of the original security, thus, increasing the value of the original security for the holder of the option.

Question 4

Why is a mortgage a type of callable bond?

Accepted Answer

The answer of Why is a mortgage a type of...

Question 5

What happens when the issuer of an American option does not exercise optimally?

Accepted Answer

The answer of What happens when the issuer of an...

Question 6

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is no lockout period.

Accepted Answer

The answer of Using the information provided at the beginning...

Question 7

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par.

Accepted Answer

The answer of Using the information provided at the beginning...

Question 8

What is negative convexity?

Accepted Answer

The answer of What is negative convexity?...

Question 9

You are given the following interest rate tree. Use it when required in the
exercises. 
-What is an American Call option?

Accepted Answer

The answer of You are given the following interest rate...

Question 10

You are given the following interest rate tree. Use it when required in the
exercises. 
-Does a callable bond have an American option embedded in it?

Accepted Answer

The answer of You are given the following interest rate...

Question 11

How is it that negative convexity is present on a callable bond?

Accepted Answer

The answer of How is it that negative convexity is...

Question 12

You notice that when no lockout period is present and for coupons above 5%, the callable bond with strike at par is priced at par. What is hap- pening?

Accepted Answer

The answer of You notice that when no lockout period...

Question 13

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is also a lockout period through which the option cannot be exercised until t =1.

Accepted Answer

The answer of Using the information provided at the beginning...

Question 14

What is the relationship between changes in interest rates and changes in value of a Principal Only (PO) strip?

Accepted Answer

The answer of What is the relationship between changes in...

Question 15

What is the relationship between changes in interest rates and changes in value of an Interest Only (IO) strip?

Accepted Answer

The answer of What is the relationship between changes in...

Question 16

You are given the following interest rate tree. Use it when required in the
exercises. 
-Does a mortgage have an American option embedded in it?

Accepted Answer

The answer of You are given the following interest rate...

Question 17

Do pass through securities have negative convexity?

Accepted Answer

The answer of Do pass through securities have negative convexity?...

Question 18

You are given the following interest rate tree. Use it when required in the
exercises. 
-Does a student loan have an American option embedded in it?

Accepted Answer

The answer of You are given the following interest rate...

Question 19

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is also a lockout period through which the option cannot be exercised until t =2.

Accepted Answer

The answer of Using the information provided at the beginning...

Quiz 12: American Options

Which is more valuable and American call option or a European call op- tion?

Why is it that as the lockout period becomes longer the price of the bond increases?

What eﬀect does an embedded option have on a security's price?

Why is a mortgage a type of callable bond?

What happens when the issuer of an American option does not exercise optimally?

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is no lockout period.

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par.

What is negative convexity?

You are given the following interest rate tree. Use it when required in the exercises. -What is an American Call option?

You are given the following interest rate tree. Use it when required in the exercises. -Does a callable bond have an American option embedded in it?

How is it that negative convexity is present on a callable bond?

You notice that when no lockout period is present and for coupons above 5%, the callable bond with strike at par is priced at par. What is hap- pening?

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is also a lockout period through which the option cannot be exercised until t =1.

What is the relationship between changes in interest rates and changes in value of a Principal Only (PO) strip?

What is the relationship between changes in interest rates and changes in value of an Interest Only (IO) strip?

You are given the following interest rate tree. Use it when required in the exercises. -Does a mortgage have an American option embedded in it?

Do pass through securities have negative convexity?

You are given the following interest rate tree. Use it when required in the exercises. -Does a student loan have an American option embedded in it?

Using the information provided at the beginning of this chapter, price a 3-year callable bond with coupon rate 5% and strike price at par. There is also a lockout period through which the option cannot be exercised until t =2.