A bond is a simple investment from the perspective of both the investor and the borrower. In exchange for a fixed amount of interest paid annually, the borrower will receive the face value of the bond until the bond expires. One type of bond can be recalled by the issuing company. This type of bond is referred to as a callable bond and investors usually require a premium to invest in these bonds, as they pose more risk.
Determine the main attributes of the bond in order to calculate its call price. You will need to know the coupon (the amount of interest the bond pays on an annual basis), the duration of the bond, and when the bond is callable.
Determine current interest rates for a Treasury bond of the same maturity. Look up the rate on the daily yield curve (see Resources for link). Let's assume the current rate on a 30-year bond is 5 percent. As the bonds are paying a higher rate than the market, the company will most likely want to re-"call" the bonds and reissue at a lower interest rate. If rates go to 10 percent in five years, the company will not want to call bonds. As such, callable bonds have an embedded "call option" which is sold to the borrower by the investor.
Calculate the call price by calculating the cost of the option. The bond has a par value of $1,000, and a current market price of $1050. This is the price the company would pay to bondholders. The difference between the market price of the bond and the par value is the price of the call option, in this case $50.
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