The position of a bondholder that is long a callable bond is equal to being
A) long a noncallable bond + long a call option on the bond.
B) long a noncallable bond + short a call option on the bond.
C) short a noncallable bond + long a call option on the bond.
D) short a noncallable bond + short a call option on the bond.
E) None of these are correct.

Question

Quizplus · Accepted Answer

When a bondholder is long a callable bond, they have the right to receive periodic interest payments and principal repayment at maturity. However, the issuer has the right to call or redeem the bond before maturity, which creates uncertainty for the bondholder. To compensate for this uncertainty, the bondholder is effectively long a noncallable bond and short a call option on the bond. Option B reflects this position of the bondholder.

The Position of a Bondholder That Is Long a Callable