Question

Consider two bonds with the same call features. One bears a premium coupon and the other a discount coupon. Explain how effective durations would be different between the two bonds. Why is there a difference?

Answer 1

Callable bonds are the bonds which can be redeemed at any date before the maturity date at face value along with interest upto that date.

A callable bonds is offered at a premium when it is offering a higher amount of interest than non callable bonds and have lower durations as well.

A callable bonds at a discount coupon means when it is offering a lower rate of interest than non callable bonds and have higher duration as well.  

The duration of callable bonds with a premium would be lesser in comparison to callable bonds which are offered at a discount.

The difference in duration of two bonds is because in longer duration bonds, the risk is also high as maturity is long .