Question

1. Comment on the circumstances upon which a bond may be callable.

2. Comment on the circumstances when a bond may be convertible.

Answer 1

1. A callable bond is a bond that can be redeemed by the issuer prior to its maturity. If interest rates have declined since the company first issued the bond, the company is likely to want to refinance this debt at the lower rate of interest. In this case, the company "calls" its current bonds and reissues them at a lower interest rate.

A callable bond is a debt instrument in which the issuer reserves the right to return the investor's principal and stop interest payments before the bond's maturity date. For example, a bond maturing in 2030 can be called in 2020. A callable, or redeemable, bond is typically called at an amount slightly above par value; the earlier a bond is called, the higher its call value. For example, a bond callable at a price of 102 brings the investor $1,020 for each $1,000 in face value, yet stipulations state the price goes down to 101 after a year.

Most municipal bonds and some corporate bonds are callable. Treasury bonds and notes, with very few exceptions, are non-callable.Advantages of Callable Bonds is that a callable bond pays an investor a higher coupon than a non-callable bond. The issuer has flexibility in payment amount and loan length when borrowing money from an investor. Issuing a bond lets a corporation borrow at a lower interest rate than a bank loan, saving the company money.

2.A convertible bond is a type of debt security that can be converted into a predetermined amount of the underlying company's equity at certain times during the bond's life, usually at the discretion of the bondholder. Convertible bonds are a flexible financing option for companies and are particularly useful for companies with high risk/reward profiles. Convertible bonds are sometimes referred to as "CVs."

Convertible bonds are issued by companies for a number of reasons. Issuing convertible bonds is one way for a company to minimize negative investor interpretation of its corporate actions. For example, if an already public company chooses to issue stock, the market usually interprets this as a sign that the company's share price is somewhat overvalued. To avoid this negative impression, the company may choose to issue convertible bonds, which bondholders are likely to convert to equity anyway should the company continue to do well.