Why doesn't the price of a callable bond exceed its call price when interest rates are falling?

By Richard Loth AAA
A:

A callable bond provides the issuer (borrowing entity) with an option to redeem the bond before its original maturity date. The ability to call a bond gives the issuer a way to respond to falling interest rates, a circumstance that allows the issuer to refinance this debt at a lower rate of interest.

Callable bonds often pay investors a higher interest rate than noncallable bonds to compensate for uncertainty and also may pay a premium for early termination of the investment. If a callable bond's coupon (interest rate) is higher than prevailing rates at the time of the call, investors won't be able to reinvest their capital in a comparable bond at as high a yield.

While it might seem reasonable to assume that in a declining interest rate environment a callable bond's price would exceed the bond's call price, experience tells us that this isn't a given. Investors need to know that there is a risk that the price at which the bond is redeemed could be below the bond's current price.

For more insight, read Call Features: Don't Get Caught Off Guard and What are the risks of investing in a bond?

RELATED FAQS

  1. Can individual investors profit from interest rate swaps?

    Find out how individual investors can speculate on interest rate movements through interest rate swaps by trading fixed rate ...
  2. How do I compare one junk bond to another?

    Discover how to identify, select and compare junk bonds. Learn the role that risk, yield and opportunity cost play in investing ...
  3. What are the main advantages of fixed income securities?

    Learn why the addition of fixed income securities are common among investors who are attempting to limit their exposure to ...
  4. If interest rate swaps are based on two companies' different outlook on interest ...

    See how two companies can swap interest rate payments and mutually benefit. See how these swaps arbitrage differences in ...
RELATED TERMS
  1. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  2. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  3. Class 3-6 Bonds

    Several classes of noninvestment grade bonds held by an insurance ...
  4. Impact investing

  5. Promotional CD rate (Bonus CD rate)

    A limited-time offer of a higher rate of return on a certificate ...
  6. Direct Bidder

    An entity that purchases Treasury securities at auction for a ...

You May Also Like

Related Articles
  1. Bonds & Fixed Income

    How to Diversify with Muni Bond ETFs

  2. Bonds & Fixed Income

    Should Junk Bond ETFs Be a Part of Your ...

  3. Professionals

    Vanguard Readies Muni Bond ETF

  4. Mutual Funds & ETFs

    Is the TLT ETF a Good Bet for the Long ...

  5. Bonds & Fixed Income

    African Equities vs. Bonds: Risks and ...

Trading Center