Ranger Inc.would like to issue new 20-year bonds.Initially, the plan was to make the bonds non-callable.If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?
A) There is no reason to expect a change in the required rate of return.
B) The required rate of return would decline because the bond would then be less risky to a bondholder.
C) The required rate of return would increase because the bond would then be more risky to a bondholder.
D) It is impossible to say without more information.
E) Because of the call premium, the required rate of return would decline.

Question

Quizplus · Accepted Answer

When a bond becomes callable, it becomes riskier to the bondholder because the issuer has the option to call the bond and repay the principal before the maturity date, and the bondholder may miss out on potential future interest payments. Therefore, the required rate of return for the bond would increase to compensate for this added risk. The call premium would not necessarily affect the required rate of return as it is a one-time cost applied when the bond is called.