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FRM Part I · FRM Exam Part I · Corporate Bonds

A company has issued a callable bond with a 6% coupon. Compared with an otherwise identical non-callable bond, which statement is correct?

The callable bond is worth less and offers a higher yield. The issuer owns the call option, so its value is deducted from the equivalent non-callable bond's price, compensating investors for call and reinvestment risk.

  1. AThe callable bond has a lower price and typically a higher yieldCorrect
  2. BThe callable bond has a higher price because the issuer holds the option
  3. CThe callable bond has the same price but a shorter maturity
  4. DThe callable bond has lower reinvestment risk for investors

Explanation

The call option belongs to the issuer and has positive value to them, so the bondholder is short that option. Callable price = non-callable price minus call value, so the price is lower and the required yield higher. Reinvestment risk is higher because calls occur when rates fall.

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