What is unique about the valuation of bonds with embedded options?

The valuation of bonds with embedded options is particularly sensitive to interest rate volatility because these options (such as call or put options embedded within the bond) provide flexibility to either the issuer or the bondholder. When interest rates fluctuate, the value of these options can change significantly, directly impacting the overall valuation of the bond.

For instance, if interest rates decline, a callable bond becomes less attractive for the issuer to call, while a putable bond provides the bondholder the option to sell the bond back at predetermined terms. This response to interest rate movements necessitates the incorporation of models that account for these variations in volatility, thereby making it a crucial component in the pricing of such bonds.

In contrast, the other choices suggest characteristics that do not accurately reflect the reality of bonds with embedded options. They do not have fixed prices regardless of market conditions, nor do they strictly adhere to the Black-Scholes model since such models are typically used for standard equity options rather than for fixed-income securities. Lastly, they are actually more affected by interest rate volatility, creating a distinct valuation challenge in comparison to traditional bonds.