A callable bond can be described by the following characteristics: Embedded Option A callable bond has an embedded call option. This call option also has some value.
So, option issuer characteristics value of the callable bond is lower than that of a normal bond. One is the normal maturity and one is the shorter life it experiences upon exercise of the call option.
Yield As with two lives, a callable bond also has two yields Yield to Maturity This is the yield of the bond if it is held till maturity. It is same as the yield of a normal bond with similar coupon and maturity.
Updated Jun 26, What Is an Issuer? An issuer is a legal entity that develops, registers and sells securities to finance its operations. Issuers may be corporations, investment trustsor domestic or foreign governments.
Yield to Call This is the yield if the bond is called before maturity. Callable Bond Uses Callable bonds give the issuer an opportunity to refinance its debt at an attractive rate.
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It can also provide a natural hedge if the issuer has floating rate linked cash inflows from its assets. For the investors, it gives them an opportunity to earn higher than the normal coupon rate for at least the life of the bond.
They also have a new asset class to diversify their portfolio. Reinvestment Risk Callable bond investors face reinvestment risk if the bond is called away when the interest rates are low.
Now, if the interest rates fall to, say 2.
Now, the investor will have to invest in the lower rate issues, even if he decides to invest in the debt issues of other companies because the interest rates in the whole economy would have fallen.
So, the investor is reinvesting at a lower rate of return and facing a reinvestment risk if he invests in callable bonds. Chen J.