In this workout, we look at a callable bond. The below bond is callable at 105. It was originally issued when interest rates were very high. Rates have since come down significantly. And the yield to maturity for a non-callable also known as a straight bond, with the same terms is 3%. What will the issuer do? So the bond is callable. That means that the issuer can buy back this bond at 105 if he so choose to do. We know that bonds become more valuable as yields come down. So it seems likely that at yields have come down significantly here, there might be worth looking into whether this bond should be called or not. So what will the issuer do? Well, what we are going to do is figure out the price for a non-callable bond, a straight bond, given that the market yield to maturity is now 3%. So let's do that here below. The price of a non-callable equivalent, we can calculate. It's going to be -PV function. The rate now is 3%.

The remaining time to maturity is five years. The annual coupon is 10. And the par value is 100. So when our pricing exactly the same bond only, it's not callable.

Hit Enter and you see the price of a non-callable equivalent is 132.1. The issuer has the right to call this bond, to redeem this bond at 105. So, of course, he will now call the bond. So he will pay out 105. And if he now issued an equivalent bond that is non-callable in the market, he would of course raise 132.1 per bond. So the conclusion is the issuer will call this bond because 105 is significantly less than 132.1.