Lecture 8

Question 1

When will a company call a bond?

Answer 1

• Call when call price < market price
• When the (market) price ↑ = interest rate ↓ - can borrow cheaply
• Thus the bond should be called when interest rate falls.

Question 2

When a bond is callable, will the coupon rate be higher or lower than a non-callable bond?

Answer 2

• Coupon rate of callable bond is higher than non-callable bond.
• If the bond price (Po) rises above the call price (FV), the company will call it.
• Bondholders have to forfeit their anticipated gains to the company.
• Callable bonds are more risky
• So, bondholders require more compensation through higher coupon rate. (interest rate bond issuer pays to bondholder).