Question

A bond is most likely to be called when?

1) when investors must reinvest at lower rates
2) when the bond sells at a large discount
3) when market yields are close to coupon rates
4) when investors can reinvest at higher rates

Answer 1

A bond is most likely to be called when investors must reinvest at lower rates, indicating that market interest rates have dropped below the bond's coupon rate, allowing the issuer to refinance at a lower cost. Option 1.

Step-by-step explanation:

A bond is most likely to be called by the issuer when market conditions allow them to refinance the debt at a lower interest rate. This typically occurs when market yields are lower than the coupon rate of the bond, making it advantageous for the issuer to redeem the old bonds and issue new ones at a lower cost. In the options provided, the scenario where investors must reinvest at lower rates (option 1) coincides with conditions under which bonds are likely to be called since this implies that market interest rates have fallen below the coupon rate of the existing bonds. Therefore, an issuer would call in the bond to refinance the debt at these new, lower rates. Options 2, 3, and 4 are less likely scenarios for a bond to be called.