Amram Inc. can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the convertible, callable bond a Exactly equal to 6%. b It could be less than, equal to, or greater than 6%. c Greater than 6%. d Exactly equal to 8%. e Less than 6%

Answer:C. Greater than 6%

Explanation:

C. Greater than 6%

Callable bonds are bonds that gives the issuer a right or privilege to redeem before the bond reaches it's maturity period. When interest rate decreases, the price of a bond increases which may induce the issuer of a bond to redeem the bond.

Callable bonds have a higher interest rate. The Higher interest rate is used to attract investors.

E) Less than 6%

Explanation:

Depending on the specific terms of the bond issuance, the interest rates could be higher, equal or lower, but generally in real life callable bonds have a lower interest rate than similar non-callable bonds.

Bondholders usually face two important risks (besides default):

reinvestment risk: the risk of not being able to reinvest bond's proceeds at the same interest rate. Only zero coupon bonds do not have reinvestment risk. interest rate risk: the risk that the interest rate increases and the bond's price decreases, it also represents an opportunity if the interest rate decreases and the bond's price increases. The longer the maturity date, the higher the interest rate risk. Since callable bonds may have a shorter maturity date, then the interest rate risk decreases.