Question

If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

Here is what I have so far:

A callable bond is a bond that can be redeemed before its maturity date. This basically means that the issuer can call the bond at a predetermined call date if they chose to. If interest rates decline in the market, the value of your callable bond will not rise as much as a regular bond would.

I'm just not sure how to explain it.

Answer 1

A callable bond is a bond that can be redeemed before its maturity date. This basically means that the issuer can call the bond at a predetermined call date if they chose to. If interest rates decline in the market, then instead of paying the higher rates the issuer will call the bond and now you would have to invest in a bond which is paying lesser rate than the originally invested rates. The value of your callable bond will not rise as much as a regular bond would because the more the rates decline the more the benficial is for the issuer to call the bond and hence the chances of the bond being called increases.