Why Callable Bonds Are not Called When the Market Price Reaches the Call Price: A Duration Argument

Samih Azar

International Journal of Business and Management, 2015, vol. 11, issue 1, 90

Abstract: It is a fact that firms do not call callable bonds when bond prices reach for the first time the call price. This paper provides an original explanation for this behavior by resorting to duration analysis. It is known that, ceteris paribus, a bond with a higher coupon, or a higher yield, has a lower duration that a bond with a lower coupon, or a lower yield. This implies that the bond that is to be called has a lower duration than the bond that replaces it. A lower duration signifies a lower interest rate risk. The firm with a callable bond will wait for market interest rates to fall further in order to equalize durations and bear the same risk. The underlying assumption is that by equalizing durations the firm keeps facing the same financial risk. In this case, it is the same amount of interest rate risk. Consequently, there are no changes in the capital structure, no redistribution effects on other debt claims, and financial leverage is unaffected. The paper provides illustrations on this active law by considering four callable bonds, with different remaining maturities, and each one with a set of two different call prices.

Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.ccsenet.org/journal/index.php/ijbm/article/download/54605/29866 (application/pdf)
http://www.ccsenet.org/journal/index.php/ijbm/article/view/54605 (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ibn:ijbmjn:v:11:y:2015:i:1:p:90

Access Statistics for this article

More articles in International Journal of Business and Management from Canadian Center of Science and Education Contact information at EDIRC.
Bibliographic data for series maintained by Canadian Center of Science and Education ().