Question

(1) What is a callable bond? (2) Why would a corporation issue a callable bond?

Answer 1

Callable bonds:

Bonds that can be redeem before its maturity date.

Reason to issue a callable bonds by corporation:

To take advantage of possible drop in interest rates.

Say, If the interest rates decreases then company redeem bonds and re-issue new bonds at lower rates. Thereby reducing the cost of capital.

Advantages of debt financing (bond) versus equity financing (stock)

Debt financing:

Debt is a cheaper source of finance. It means cost of debt is lower than cost of equity. It has tax advantage.

Equity financing:

It has less risk because it does not have fixed monthly payment.