Question

Discuss why investors dislike a call provision in the bond indenture? How does this affect the yield on a callable bond?

Answer 1

Call provision implies that the bond issuer can buyback the issued bonds at a date prior to its maturity if it finds is profitable. He will generally do this when the market interest rates fall. This is done to refinance the debt at the current lower rate. From the point of view, the call provision is profitable.

But looking from the investor point of view, he is left with so much money which he now has to invest at the lower interest rate. This is the reason why investors dislike the call provision. Bonds with call features are considered riskier due to the higher reinvestment risk and therefore demand higher yield. So in comparison to a straight bond, their price is lower and yield is higher.