Hi guys
Can anyone enlighten me on why is a callable bond more likely to be called when coupon rates are higher?
Isn’t the issuer more likely to keep their current investment since issuing another bond would require a higher coupon payment?
Thanks!
think about it the other way.
If a zero coupon bond was issued, is the issuer likely to call the bond? hopefully you agree the answer is no.
as the coupon rate increases, then it’s more likely the bond is called. if the bond is called, then usually that means interest rates have fallen, so refinancing would be cheaper, lower coupon…
Howdy.
Reread what you wrote.
It says that they’re more likely to call a bond with a higher coupon, not that they’re more likely to call a bond when interest rates are high.
They’re more likely to call a bond when interest rates are low (i.e., below the coupon rate), and that is more likely when the coupon is high than when the coupon is low.
You’re welcome.
I would think of it this way:
Coupon rate < Yield: Bond is priced at a discount
Coupon rate = Yield: Bond is priced at par
Coupon rate > Yield: Bond is priced at a premium
So basically if yield does not change, increase in coupon rate will result in increase in price of the bond. If the bond increases in price, it will more likely to be called.
Hope this helps 