Why is the value of an option-free bond unaffected by interest rate volatility?

The value of an option-free bond remains unaffected by interest rate volatility primarily because these bonds do not include embedded options. An embedded option allows bondholders or issuers certain rights, such as the ability to call the bond before maturity or convert it into equity. These options can significantly affect a bond’s value, particularly when interest rates fluctuate.

In contrast, option-free bonds are straightforward securities that provide fixed cash flows in the form of regular coupon payments and the return of principal at maturity, without any additional rights tied to the bond itself. Therefore, their valuation is primarily influenced by changes in interest rates and the prevailing yield curve, rather than the potential benefits or drawbacks brought about by fluctuating interest rates through options.

This foundational structure of option-free bonds allows investors to predict their value more accurately as interest rate volatility does not introduce the complexities associated with embedded options.