A call provision permits a company to repurchase or call an entire bond issue at some price during a predetermined period. Common sense tells us that a call provision has positive value to the company and negative value to the creditor. If interest rates fall and bond prices go up, the option to buy back the bonds at a call price that is lower than would be true otherwise is valuable. Of course, bond investors know this and take into account the call provision.

Suppose Venture Capital Corp. (VCC) has an outstanding 30-year bond that pays semiannual coupons. It is a 7 percent bond with a $1,000 par value and is currently selling at par.

Further suppose that because of potential changes in interest rates, the price of the VCC bond could be $700 or $1,300 at the end of the year with equal odds.

1. What is the expected value of the VCC bonds after one year? (.5 × $700) + (.5 × $1,300) = $1,000 

2. What is the expected value of the VCC bonds if they are callable at $1,000? (.5 × $700) + (.5 × $1,000) = $850 

If the bonds are callable, the expected bond value can be less than if the bonds are not callable. If the actual bond value rises above the call price, the company will call it. Therefore, other things equal, the bondholder will not pay as much for a callable bond.