Biggs, Inc., holds a bond portfolio that is, on average, trading below par value. They have faced some cash flow problems of late and have used the bond interest payments for operating expenses. The bonds are callable. Given the current situation, Biggs faces which types of risk? A) Call risk. B) Interest rate risk and reinvestment risk. C) Interest rate risk and call risk. D) Interest rate risk.
C
Let’s see if I can get two in a row: OK trading below par means the bond has a lower interest rate than the market, so it isn’t call rsik or reinvestment risk. Cashflow problems would mean they didn’t reinvest the interest payments at the same rate as the coupon rate, leading to interest rate risk. The answer is D.
That’s exactly what I answered. Turns out it is D. Although the bonds are callable, they wont be called as they are trading below par. So there is no call risk. - Sejal
You are on a roll trek7000
I would say D b/c the bonds are trading at a discount which means current interest rates are higher than the interest rate on the bonds Biggs is holding. So the issuer would not want to call them - they would have to reissue at a higher interest rate.
so true, callable-bonds are never going to get called if the market interest rates are higher than the interest rates on the bonds. - Dinesh S