Multiple Choice
Which of the following characteristics designates a premium bond?
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11. Long Term Liabilities
Introduction to Bonds and Bond Characteristics
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Which type of bonds typically offer a higher yield to investors, all else being equal?
A
Callable bonds
B
Noncallable bonds
Verified step by step guidance1
Understand the concept of callable bonds: Callable bonds are bonds that can be redeemed by the issuer before their maturity date. This feature gives the issuer flexibility to refinance debt if interest rates drop, but it introduces reinvestment risk for investors.
Understand the concept of noncallable bonds: Noncallable bonds cannot be redeemed by the issuer before maturity. This provides investors with more certainty about the bond's cash flows and reduces reinvestment risk.
Compare the risk profiles: Callable bonds are riskier for investors because the issuer might call the bond when interest rates decrease, forcing investors to reinvest at lower rates. Noncallable bonds are less risky in this regard.
Analyze the yield implications: To compensate for the additional risk associated with callable bonds, issuers typically offer higher yields on callable bonds compared to noncallable bonds, all else being equal.
Conclude the reasoning: Callable bonds generally offer higher yields to attract investors who are willing to accept the reinvestment risk associated with the callable feature.
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