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CFA Level I · CFA Level I Exam · Fixed-Income Cash Flows and Types

An investor holds a bond with a call option that belongs to the issuer. Compared with an otherwise identical non-callable bond, the callable bond most likely:

The callable bond most likely offers a higher yield. The issuer owns the option and may redeem the bond when rates fall, exposing the investor to reinvestment risk and capped price gains, so investors demand extra yield and the bond trades at a lower price.

  1. Aoffers a lower yield to compensate for the call feature
  2. Boffers a higher yield to compensate for reinvestment riskCorrect
  3. Chas a higher price because the issuer holds extra flexibility

Explanation

The issuer benefits from the call option and would call when rates fall, leaving the investor with reinvestment risk and limited price upside. The investor therefore requires a higher yield, so the callable bond has a lower price, not a higher one.

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