Briefly discuss what are call provisions, sinking fund, interest rate risk and reinvestment risk. Which of these provisions make bonds more or less risky?
Support with examples from the real business case.
The call provision allows the issuer to repurchase the bond at a specified call price before the maturity date. Call Features are there to protect the issuing company from interest rate risk.
If a company issues a bond with a high coupon rate when market interest rates are high, and interest rates later fall, the firm might like to retire the high-coupon debt and issue new bonds at a lower coupon rate to reduce interest payments. This is called refunding.
If the company has borrowed money in a high interest rate environment and interest rates fall, the company would like to refinance the issue just as a person would refinance his house to take advantage of the lower rates. A call provision means that the company can retire the bond before maturity date.
A call provision makes bonds more risky for the investor, since he would have to take the proceeds and ...
The solution discusses call provisions, sinking fund, interest rate risk and reinvestment risk.