“Bond buyers are disadvantaged by the call provision and have more reinvestment risk because their bonds will only be called (redeemed prior to maturity) when the proceeds can be reinvested only at a lower yield. For this reason, a callable bond must offer a higher yield (sell at a lower price) than an otherwise identical noncallable bond. The difference in price between a callable bond and an otherwise identical noncallable bond is equal to the value of the call option to the issuer.”
Would you clarify for me how the value of the call option to the issuer is measured when it is first issued? Shouldn’t we know how interest rate will fluctuate to measure that?