non callable callable Coupon 3% 4% call price N.A 1100 If interest rate expected to fall,which...

	non callable	callable
Coupon	3%	4%
call price	N.A	1100

If interest rate expected to fall,which bond will you choose.Explain

Solutions

Expert Solution

First let me explain the relationship between interest rates and coupon rate of the bond.

The coupon rate and Interest rates are inversely related. This means in case interest rate is more than coupon rate then the price of the bond will fall since the investor may sell the bond and invest in other security which pays more return for same tenure as that of bond.

Inversely it can be interpreted as per the requirement in the question if interest rate is expected to fall below coupon rate then in this case we shall buy the bond whose coupon rate is higher since the investor will earn higher return.

In the given question the investor shall buy the callable bond since its coupon rate is higher i.e. it is paying interest @ 4% and in case if the bond is redeemed before the tenure of the bond by the issuer then the redeemable value per bond will be more than the face value of the bond. Therefore, the investor will be able to earn higher return.

Conclusion:

The investor should purchase Callable bond because its coupon rate is higher.

jeff jeffy answered 5 months ago

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