Question

Which of the following events would make it more likely that a company would call its outstanding callable bonds?

Market interest rates decline sharply.

The company’s bonds are downgraded.

The company's financial situation deteriorates significantly.

Market interest rates rise sharply. Inflation increases significantly.

Answer 1

Market interest rate decline sharply is the event that would make it more likely that a company would call its outstanding callable bonds.

A callable bond, also known as a redeemable bond, is a bond that the issuer may redeem it before the maturity date. A callable bond allows the issuing company to pay off their debt early. A business may choose to call their bond if market interest rates move in a favorable direction and will allow them to borrow at a more beneficial rate. Callable bonds also benefit investors as they typically offer an attractive interest rate or coupon rate due to their callable nature. 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. Corporations may issue bonds to fund expansion or to pay off other loans. If they expect market interest rates to fall, they may issue the bond as callable, allowing them to make an early redemption and secure other financings at a lower rate. The bond's offering will specify the terms of when the company may recall the note.

If market interest rates decline after a corporation floats a bond, the company can issue new debt, receiving a lower interest rate than the original callable bond. The company uses the proceeds from the second, lower-rate issue to pay off the earlier callable bond by exercising the call feature. As a result, the company has refinanced its debt by paying off the higher-yielding callable bonds with the newly-issued debt at a lower interest rate. Paying down debt early by exercising callable bonds saves a company interest expense and prevents the company from being put in financial difficulties in the long term if economic or financial conditions worsen.

As in the case of any thing callable bond also has certain merrits and demerrits for both the issuer company and the investors, they are Pay a higher coupon or interest rate, Investor-financed debt is more flexibility for the issuer, Helps companies raise capital, Call features allow recall and refinancing of debt, Investors must replace called bonds with lower rate products, Investors cannot take advantage when market rates rise,Coupon rates are higher raising the costs to the company.