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. C) Interest rate risk and reinvestment risk. D) Interest rate risk and call risk. Your answer: D was incorrect. The correct answer was B) Interest rate risk. The bonds are trading below par, so rates have increased and, at this point, neither call risk nor reinvestment risk are significant. The firm faces interest rate risk because their bond portfolio has decreased in value due to increasing market interest rates. How do you not have call risk if the bonds are currently callable?
Rates have increased; as an issuer if I call I’d have to re-issue at higher interest rates. Additionally, would have to call at least at par…bonds are worth less than that.
The callable feature is positive for the issuer of the bond and negative for the investor who buy the bond. Hence, no call risk for the issuer