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Understanding Option Elements Embedded in a Bond

Consider a callable U.S.-dollar corporate bond issued on December 1, 1999, by the hypothetical ABC Corp. with a fixed semiannual coupon of [Pg.189]

FIGURE 11.1 Call Schedule for the ABC Corp. 6 Percent Bond [Pg.190]

6 percent and a maturity date of December 1, 2019- FIGURE 11.1 shows the bond s call schedule, which follows a form common in the debt market. According to this schedule, the bond is first callable after five years, at a price of 103 after that it is callable every year at a price that falls progressively, reaching par on December 1, 2014, and staying there until maturity. [Pg.190]

The call schedule works like this. If market interest rates rise after the bonds are issued, ABC Corp. gains, because it is incurring below-market financing costs on its debt. If rates decline, investors gain, because the value of their investment rises. Their upside, however, is capped at the applicable call price by the call provisions, since the issuer will redeem the bond if it can reduce its funding costs by doing so. [Pg.190]


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