Question

Alex Smith, is considering an investment in a corporate bond, or a callable corporate bond. He

has asked you to explain each and how they differ. Assume: Par=$1,000, Coupon Rate=4%, Market

Rate=3%, Remaining Term=9yrs, Remaining Term to Call=4yrs, typical call premium applies

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

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

Answer 1

Bond is an financial instrument of indebtedness of the bond issuer to the holder. The bond can be issued by the companies, banks or by government.The bond is a fixed income instrument which provides coupons to holder.The bonds can be premium bond or discount bound, zero coupons bond etc.

corporate bond

The bond issued by the corporates is a corporate bond. The companies issues this in order to raise the funds for its business.

callable corporate bond

The corporate bond embedded with the call option is a callable corporate bond. Callable means the bond holder has a right to call its bond i.e it can ask the company to repay the amount before the maturity of bond.In Puttable bond the issuer of bond i.e company has an option to go for redemption before the maturity. The excercise of the above options depends on the interest rate in the market and risk appetaite of the invester.

If Joe is very risk averse, then he should go for callable bonds since he can call for redemption of securities at any time during 4 years. Therefore reducing duration and interest rate risk.