Question

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is callable at par in 5 years, while the other is callable at par in 10 years. If interest rates drop by 200 basis points shortly after issuance, which statement is TRUE?

Answer 1

The 10 year callable bond will appreciate more than the 5 year callable bond.

Step-by-step explanation:

A callable bond is a type of bond which the issuer may call back, may purchase it back from the holder at a date before the stated maturity date to pay off debt early. In this case, if the interest rates fall by 200 basis points, the five year callable bond can be called in 5 years time if the issuer believes it to be more beneficial and so will appreciate less than the 10 year callable bond.