Not all bonds are plain “lend money, collect coupons, get paid back at maturity.” Two common variations change the deal in important ways.
Callable bonds
A callable bond gives the issuer the right to repay it early, at a set price, before maturity. Why would they? The same reason you’d refinance a mortgage: if interest rates fall, the issuer can call the old, higher-coupon bond and reborrow more cheaply.
That option is bad for you, the holder:
- Your best-case upside is capped — just when falling rates would have lifted your bond’s price most, it gets called away at the call price.
- You’re handed cash to reinvest at the new, lower rates.
This is the negative convexity from the convexity lesson in action. To compensate, callable bonds pay a higher yield than otherwise-identical non-callable ones — your reward for selling the issuer that option.
Inflation-linked bonds
The fixed payments of a normal bond are quietly eroded by inflation — a fixed coupon buys less each year as prices rise. Inflation-linked bonds (such as TIPS in the US) fix this: their principal (and so their coupons) rises with an inflation index.
The trade: they protect your real (after-inflation) return, but in exchange you accept a lower starting yield than a comparable conventional bond. You’re buying insurance against inflation surprises — valuable if inflation jumps, less so if it stays tame.
The takeaway
Callable bonds let the issuer repay early when rates fall — bad for holders, so they pay a higher yield (negative convexity). Inflation-linked bonds grow with inflation to protect your real return, in exchange for a lower starting yield. Both are about who bears which risk. (This is education, not investment advice.)