Loading the player...

What is a 'Callable Bond'

A callable bond is a bond that can be redeemed by the issuer prior to its maturity. If interest rates have declined since the company first issued the bond, the company is likely to want to refinance this debt at a lower rate of interest. In this case, the company calls its current bonds and reissues them at a lower rate of interest.

BREAKING DOWN 'Callable Bond'

A callable bond means the issuer can return the investor's principal and stop interest payments before the bond's maturity date. For example, a bond maturing in 2030 can be called in 2020. A callable, or redeemable, bond is typically callable slightly above par value; the call value increases the earlier a bond is called. For example, a bond callable at a price of $102 brings the investor $1,020 for each $1,000 in face value, yet stipulations state the price goes down to $101 after a year. Most municipal bonds and some corporate bonds are callable.

Call protection means a set time where the bond cannot be called. The issuer must clarify whether a bond is callable and the exact terms of the call option, including when it can be redeemed and what the price will be when the bond is first sold.

Advantages of Callable Bonds

A callable bond pays an investor a higher coupon than a non-callable bond. The issuer has flexibility in payment amount and loan length when borrowing money from an investor. Issuing a bond lets a corporation borrow at a lower interest rate than a bank loan, saving the company money.

Disadvantages of Callable Bonds

When a company reissues a bond at a lower interest rate, the bond costs the investor more than when it was originally issued. The company can call a bond at a price below the market price. The bondholder must turn in the bond to get back the principal; no further interest is paid. An investor might reinvest at a lower interest rate and lose potential income. The price of a callable bond will not be much higher than its call price, as lowering interest rates mean calling the bond is likely. An investor must consider the yield-to-call (YTC) and yield-to-maturity (YTM) when analyzing potential returns for a callable bond to ensure potential income matches his objectives. A callable bond may not appropriate for an investor seeking regular income and predictable returns.

Types of Call Features

Optional redemption lets an issuer redeem its bonds when it chooses. For example, a municipal bond has call features that may be exercised after a set time period, typically 10 years. Sinking fund redemption requires the issuer to adhere to a set schedule while redeeming a set portion or all of its bonds. Extraordinary redemption lets the issuer call its bonds before maturity if specific events occur, like if the underlying project is damaged or destroyed.

RELATED TERMS
  1. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Call Privilege

    The provision in a bond indenture that gives the bond issuer ...
  3. Noncallable

    A financial security that cannot be redeemed early by the issuer. ...
  4. Term Bond

    Bonds from the same issue that share the same maturity dates. ...
  5. Doubling Option

    A sinking fund provision that gives a bond issuer the right to ...
  6. Callable Preferred Stock

    A type of preferred stock in which the issuer has the right to ...
Related Articles
  1. Investing

    Callable Bonds: Leading A Double Life

    Find out more about these dangerous and exciting cousins to regular bonds.
  2. Investing

    Bond Call Features: Don't Get Caught Off Guard

    Learn why early redemption occurs and how to avoid potential losses.
  3. Investing

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  4. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  5. Investing

    Understanding Redemption

    In the investing world, redemption refers to cashing out the value of bonds or mutual funds.
  6. Investing

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  7. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  8. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  9. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
RELATED FAQS
  1. Under what circumstances might an issuer redeem a callable bond?

    Understand why an interest rate drop usually compels bond issuers to redeem callable bonds and re-issue them at the new, ... Read Answer >>
  2. Why doesn't the price of a callable bond exceed its call price when interest rates ...

    A callable bond provides the issuer (borrowing entity) with an option to redeem the bond before its original maturity date. ... Read Answer >>
  3. What risk factors should investors consider before purchasing a callable bond?

    Understand the difference between callable and non-callable bonds and consider all the various risk factors associated with ... Read Answer >>
  4. What are the advantages of investing in a callable bond?

    Learn about the biggest advantage to an investor of purchasing a callable bond, which is that it almost invariably pays higher-than-market ... Read Answer >>
  5. Why is a premium usually paid on a callable bond?

    Understand the nature and characteristics of callable bonds, and specifically why those factors lead issuers to offer a premium ... Read Answer >>
  6. What are the accounting entries when a company issues a callable bond?

    Learn how callable bonds are treated on balance sheets, and understand why callable bonds often pay investors a premium for ... Read Answer >>
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  3. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  4. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  5. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  6. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
Trading Center