Tax Differentials and Callable Bonds.

The article explains the prevalence of callable corporate bonds as the result of a tax differential in the United States, which gives borrowers a preference for callable rather than noncallable or puttable bonds. The tax effect is based on the difference in marginal tax rates between profitable borrowers and typical lenders. Profitable corporations with marginal tax rates of about 50 percent, while lenders' rates might be close to zero produce an incentive toward callable bonds which can be redeemed or replaced with a lower-cost bond. Transactions stated after taxes, after-tax discount rates, financial flexibility and interest rate premiums, government bonds, and a model of option provisions and interest rate changes are mentioned.