An analyst makes the following two statements about putable bonds:
Statement 1:
As yields rise, the price of putable bonds will fall more quickly than similar option-free bonds (beyond a critical point) due to the decline in value of the embedded put option.
Statement 2:
As yields fall, the price of putable bonds will rise more quickly than similar option-free bonds (beyond a critical point) due to the increase in value of the embedded put option.
Are the analyst’s statements correct? A. Both statements are correct. B. Neither statement is correct. C. Only one of the statements is correct.
Both statements are incorrect. As yields rise, the value of the embedded put option in a putable bond increases and (beyond a critical point) reduces the decline in the value of the bond compared with a similar option-free bond. As yields fall, the value of the embedded put option decreases, and (beyond a critical point) the putable bond behaves much the same as a similar option-free bond since the embedded put option has little or no value.
