The call-option value of a callable bond is likely to be high when:
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A. B. C. D.A
The correct answer is A. Interest rates are volatile.
A callable bond is a type of bond that gives the issuer the option to call back the bond before it matures, thus retiring the bond earlier than the maturity date. This feature benefits the issuer as it allows them to refinance the debt at a lower interest rate when interest rates decrease.
The call-option value of a callable bond represents the value of the issuer's right to call back the bond before its maturity. If interest rates decrease, the issuer is more likely to call back the bond, and therefore, the call-option value increases. On the other hand, if interest rates increase, the issuer is less likely to call back the bond, and the call-option value decreases.
In general, when interest rates are volatile, the call-option value of a callable bond is higher. This is because the likelihood of the issuer calling back the bond changes with interest rate movements, and the call-option value reflects this uncertainty. Therefore, if interest rates are expected to be volatile, the call-option value of a callable bond will be higher.
Options B, C, and D are incorrect as they do not necessarily impact the call-option value of a callable bond. A low interest rate environment (option B) may make it more likely for the issuer to call back the bond, but it is not the only factor that determines the call-option value. Similarly, a high interest rate environment (option C) may make it less likely for the issuer to call back the bond, but again, other factors need to be considered. Finally, market inefficiencies (option D) may impact the bond price, but they are not directly related to the call-option value.