Question

Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return

Answer 1

Answer:

c. The required rate of return would increase because the bond would then be more risky to a bondholder.

Explanation:

Options to the question are "a. There is no reason to expect a change in the required rate of return.    b. The required rate of return would decline because the bond would then be less risky to a bondholder.    c. The required rate of return would increase because the bond would then be more risky to a bondholder.    d. It is impossible to say without more information.    e. Because of the call premium, the required rate of return would decline."

Bonds will be usually called back when the new interest rates are lower, this will lower the interest income of the investors. However, call premium cannot always compensate all the income loss by investors.