CHAPTER 3 DESCRIBED an option’s total value in terms of its intrinsic and time values. Intrinsic value was said to pertain only to options that may be profitably exercised immediately and was measured as the difference between the option’s strike price and the underlying security’s current market price. Time value was discussed within the context of the market’s view of the expected profitability of exercising the option on a future date.
In general, outstanding nonbullet bonds contain embedded options that possess little or no intrinsic value. This is because bonds with currently exercisable in-the-money options tend to be redeemed by the option holders—issuers in the case of callable bonds and investors in the case of ...