Lee is considering buying one of two newly-issued bonds. Bond A is a twenty-year, 7.5% coupon bond that is non-callable. Bond B is a twenty-year, 8.25% bond that is callable after two years. Both bonds are comparable in all other aspects. Lee plans on holding his bond to maturity. What should Lee do if he feels that interest rates are going to decline by 2% in the near future and then remain relatively stable thereafter?

Question

Quizplus · Accepted Answer

If Lee believes interest rates will decline, Bond A is more attractive because it is non-callable. This means Lee can lock in the higher interest rate for the full term, whereas Bond B could be called away in a lower interest rate environment, forcing Lee to reinvest at lower rates.

Lee Is Considering Buying One of Two Newly-Issued Bonds