Question

. Consider two bonds (A and B) that are homogeneous except that Bond A is “callable” (i.e. has a call provision). Which bond will have a higher yield? Why?

Answer 1

Solution : Callable bonds have a higher yeild than non callable bonds.

This is because callable bonds are those bonds which can be redeemed or call back by the issuer when ever the interest rate in the market lowers down. And the issuer of the band can issue those bonds again at lower coupon rate.

Since the investor here is taking a huge risk that the bonds can be called at anytime before maturity and once he gets paid he has to invest those fund at lower rate of interest, he will be willling to invest in callable bonds only if the callable bonds provides him higher yeild. That is the reason callable bond bears a higher yeild rate.