Question

Your friend, Jamie lynn, is considering an investment in a corporate bond, or a callable corporate bond. she

has asked you to explain each and how they differ. Assume: Par=$1,000, Coupon Rate=5%, Market

Rate=6%, Remaining Term=9yrs, Remaining Term to Call=4yrs, typical call premium applies

• Provide a write up comparing and contrasting the different bond types

• Use common models found in the text to help him understand how to evaluate potential

returns from each

• Under the assumption that Jamie is very risk averse, make a recommendation, with support

Answer 1

A corporate bond is a debt issued by a company to raise capital. It cannot be redeemed before the date of maturity.

A callable bond on the other hand is a typeof bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the date of maturity.

Callable bonds generally have higher coupon rate as compared to corporate bonds.

Return for corporate bond can be calculated by :- coupon rate * par value * remaining term

= 5% * 1000 * 9 = $450

Return for ccallable bond can be calculated in the foloowing way :-

step 1: Add 1 to the coupon rate = 1+0.05 = 1.05

step 2: raise this value topower of no.of years to call = 1.05⁴ = 1.2155

step 3 : multiply this factor by face value = 1.2155*1000= 1216

step 4: subtract the bond's par value from this value = 1216-1000= $216

return on callable bond = $216

Since jamie is very risk averse he would invest in callable bonds as the callable bonds can be called back when the rate of return is about to lower down.So, Jamie would be very interested in investing in callable bonds rather than non callable corporate bonds.