Question: What is the possible risk/disadvantages for an investor in case of bond having “call� provision?
Answer: If you see investor can have, three disadvantages of the call provision and hence faces call risk. - The cash-flow pattern of a callable bond is not known with certainty. - Because the issuer can call the bonds when interest rates reduces, and the investor is exposed with reinvestment risk. Because he/she has to reinvest the proceeds received when the bond is called at lower interest rates by borrower. - Price increase of a bond will be restricted because its a callable bond, it may not rise much above the price at which the issuer can call the bond.
Question: Which type of issuer can have callable bonds?
Answer: Usually, Agency, corporate, and municipal bonds can have embedded option like to call, or terminate, the issue before the stated maturity date.
Question: How callable bonds are compensated?
Answer: Investor is typically compensated for taking the risk of call by means of a lower price or a higher yield, it is not easy to determine if this compensation is sufficient. And the returns may differ in great amount then non-callable bonds. This also depends on various conditions defined in call provisions and market conditions.
Question: Can MBS (Mortgage Backed Security) has the callable options?
Answer: All MBS, which are created based on the real estate mortgage can be called any time. Because the borrower can any time do pre-payment. Hence, all mortgage-backed securities have this option.