When the volatility of the yield for a bond increases, which of the following statements is true:

When the volatility of the yield for a bond increases, which of the following statements is true:
A . The VaR for the bond decreases and its value increases
B . The VaR for the bond increases and its value decreases
C . The VaR for the bond decreases and its value is unaffected
D . The VaR for the bond increases and its value stays the same

View Answer

Answer: D

Explanation:

The VaR of a fixed income instrument is given by Duration x Volatility of the interest rate x z-factor corresponding to the confidence level. Therefore as the volatility of the yield goes up, the value at risk for the instrument goes up.

At the same time, the value of the bond is given by the present value of its future cash flows using the current yield curve. This value is unaffected by the volatility of the underlying interest rates. Therefore a change in volatility of interest rates does not affect the value of the bond.

Therefore Choice ‘d’ represents the correct answer.