Let us consider the base case first of 2 years at a 5% premium to the face value of the bond. How does it work out?

Bond Yield Example Data

Face Value

? 1,000

Annual Coupon Rate

8.00%

Annual Required Return

9.00%

Years to Maturity

5.0

Years to Call

2.0

Call Premium %

5.00%

Payment Frequency

4

Value of Bond

? 960.09

Bond Yield Calculations

Current Yield

8.33%

Yield to Maturity

9.00%

Yield to Call

12.53%

In the above case, when the bond is callable at a premium of 5% after 2 years, the bond has an attractive yield to call of 12.53%. That will surely make it attractive to the investors and they will be interested in buying the bond despite the call option. But what if the bond was callable after 4 years instead of 2 years but at an 8% premium? Will it still be attractive? Check the table below.

Bond Yield Example Data

Face Value

? 1,000

Annual Coupon Rate

8.00%

Annual Required Return

9.00%

Years to Maturity

5.0

Years to Call

4.0

Call Premium %

8.00%

Payment Frequency

4

Value of Bond

? 960.09

Bond Yield Calculations

Current Yield

8.33%

Yield to Maturity

9.00%

Yield to Call

10.87%

In the above case the 5 year bond is callable after 4 years but at a premium of 8%. Despite the higher premium, the longer callable tenure means that the yield to call (YTC) is down to 10.87%. This may not be too attractive to the investors and they may prefer an alternate bond that is not callable.

In short, the callable bond will be attractive only if the bond is going to be called with a shorter time frame and at a higher premium to the par value. Alternatively, the investors may not find this callable bond too attractive and they may prefer to invest in a bond without the callable option.