see also post on price spread between callable and non-callable bonds
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To a buyer of a callable bond, the call feature poses a “call risk”.
Q: Why is early repayment a risk to the lender? To me it sounds like an added value.
A: The issuer only exercises this option when advantageous. Advantageous to issuer always means bad luck for the counter-party i.e. bond holders.
Bond is called only in a low-interest period. Imagine you receive 10% pa coupons year after year and suddenly you get the principal back but you can get only 0.0% pa (like Japan or Europe) from now on 😦
When an investor is comparing 2 otherwise identical bonds, the one with the call option is worth less because there’s a risk (“call risk”) that cash-flow will be lower after the call option exercise.
Yield-to-worst is basically the lowest yield that could be realized if the embedded call is exercised. Buyer assumes what could go wrong WILL go wrong — Murphy’s Law. In such an analysis, the worst case to the investor is an early repayment, and reduced cash-flow subsequently.
However, my friend Ross (in the bubble room) in Macquarie said the callable bond they hold could get called and as a result they could realize a windfall profit. He said it’s a good thing but I believe they would forgo the high coupon interest.
