Question

A company issues two bonds that identical in all ways except one is callable and the other is not.

Which one will investors pay more for (i.e., accept a slightly lower return)? Explain why.

Answer 1

A callable bond is a bond where issuer may redeem the bond before stated maturity date. So, a callable bond provides an option to the issuer to pay off their debts early. An issuer will choose to call their bond if market interest rate falls or expected to fall, because issuer will be able to issue new bond at less interest rates.

If two bonds are identical in all ways except that one is callable and the other is not, a callable bond makes disadvantage to the bondholder. It can be called if interest rates fall. Investor will have to receive less return in that case.

So, The investor will pay more for the bond which is non-callable if they are identical in all ways.