in Schweser notes, book5, P15, “Call provisions”, the example says , a bond can called after 5 years at a price of 110(110% of par), with the call price declining to 105(105% of par) after 10 years. – my question is what if the bond is issued or bought by investors at premium price 120% of par. When it is called back. It seems a big loss for investors. Pls also explain when it is issued or bought at discount price 99% of par.
if you bought a bond at 99 and then got called during the first premium call date at 110 (even if it was merely a day after you settled your purchase) you have hit a home run in the bond world. sometimes a bond will be purchased for a price higher then the premium call price, in which case if you paid 120 and were then called at a time afterward (too soon for your premium to amortize to at least the price you were called)… you book a loss on that trade. sometimes (usually not in the corporate market, but frequently in the muni market) bonds are purchased at a price higher then a call price even after the call date has passed and current rates are lower then the coupon. this is usually due to some inefficiencies caused by the hurdle of underwriting costs for a refunding issue to those of unsophisticated public treasurers.
Char-Lee Wrote: ------------------------------------------------------- > sometimes (usually not in the corporate market, > but frequently in the muni market) bonds are > purchased at a price higher then a call price even > after the call date has passed and current rates > are lower then the coupon. this is usually due to > some inefficiencies caused by the hurdle of > underwriting costs for a refunding issue to those > of unsophisticated public treasurers. A buddy of mine makes lots of money this way - he just calls up treasurers or whoever is in charge of refunding and asks them if they are going to do it. If it’s Bubba who wants to go fishing…
It is a big loss to the investor, that’s why we say call provision is a risk to bond buyer. So the callable bond is usually priced lower attract buyers who require higher yeild to riskier investment.