Firms That Issue Callable Bonds Have the Option of Repaying

question 66

Multiple Choice

Firms that issue callable bonds have the option of repaying the principal to the bond buyers before the stated maturity date for the bonds. Firms may call their bonds before maturity in order to avoid making some of the coupon payments. Should we expect the price of a callable bond to be higher or lower than the price of a non-callable bond that has the same coupon payment, principal, and effective yield?

• A) Price of the callable bond should be higher.
• B) Price of the bonds should be the same.
• C) Price of the callable bond should be lower.
• D) We need to know the year in which the bond is called in order to compare the prices.

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Definitions:

Periodic Interest Rate

The interest rate charged or paid over a particular period of time, often less than a year, such as monthly or quarterly.

Annuity

A monetary product ensuring regular payouts to an individual, commonly incorporated into strategies for retirement.

Payment Interval

The frequency at which payments are made or received, such as monthly, quarterly, or annually.

Compounded Monthly

Interest calculation method where the interest is added to the principal every month, which then earns interest the following month.