Question

Which of the following statements is CORRECT? a. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond. b. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond. c. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate. d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate. e. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.

Answer 1

C) Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

Step-by-step explanation:

Usually the value of callable bonds is lower than the price of similar non-callable bonds since the issuer gains extra value from the call option. The issuer has the right to call the bonds, not the investor, so callable bonds carry greater risk. E.g. if the market interest rate decreases and falls below the coupon rate of a callable bond, the issuer might call it (if enough time has passed) and the investor will lose.

If the interest rate is above the coupon rate, the issuer will not call the bonds since they are paying below market interest.

Answer 2

C

Step-by-step explanation:

Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.