Do borrowing costs increase or decrease for callable bonds or bonds with detachable stock warrants?
When debt securities are issued with a call feature, the debt can be retired at the discretion of the company until some specified future date. The call feature represents value to the issuing company, much like a call option on equity. The issuer must compensate investors for providing this option. Therefore, the interest rate on callable bonds is typically higher than those on noncallable bonds of the same credit quality. That is, the borrowing costs increase on bonds with a call feature.The opposite is true of bonds with detachable stock warrants. A stock warrant provides the bondholder with the right to purchase shares of common stock in the issuing company at a specified price during a defined period of time. The warrant’s strike price is typically at, or higher than, the current market price of the company’s stock. Nonetheless, the warrant provides value to the bondholder in the form of a call option on the company’s equity. Because these warrants add to the potential total retur
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