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CFA Level I · CFA Level I Exam · Yield-Based Bond Convexity and Portfolio Properties

An investor holds a putable bond and an otherwise identical option-free bond. If market yields rise sharply, the putable bond's price is most likely to:

The putable bond falls less than the option-free bond. As yields rise, the embedded put gains value because the holder can sell the bond back at the put price, which creates a price floor and reduces the decline.

  1. Afall by more than the option-free bond because of the embedded put
  2. Bfall less than the option-free bond because the put price creates a floorCorrect
  3. Cfall by the same amount because the put option is out of the money

Explanation

When yields rise, the put becomes more valuable because the holder can sell back at the exercise price. This puts a floor under the bond price, so it falls less than the option-free bond. The put is in the money, not out of the money, in this scenario.

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