Suppose that Acme Inc. is issuing 10-year bonds that are not callable. The required rate of return that the firm must pay to bondholders is 10%. They are also considering some callable bonds, which are identical to the proposed issue, but will be callable after 5 years at a 5% call premium. How would the callable feature affect the required rate of return?

Because of the call premium, the required rate of return would decline.

There is no reason to expect a change in the required rate of return.

The required rate of return would decline because the bond would then be less risky to a bondholder.

The required rate of return would increase because the bond would then be more risky to a bondholder.

The required rate of return would increase because of the 5% call premium.