A:

Bond issues can contain what is referred to as a call provision, which is a right afforded to the issuing company enabling it to refund the bondholder the par value of his/her bond (perhaps including a small call premium) at the company's discretion. Any and all call provisions applicable to a bond issue will be included in the bond issue's indenture, so be sure you understand the details of the indenture for the bond you are buying.

Most of today's corporate debentures are callable bonds, and about 70% of municipal bonds are callable too - so if you are interested in trading bonds, you should understand how they work.

Call provisions contain several specific rules which apply to the issuer and the bondholder. First, there will generally be a waiting period, starting immediately after the bond issue is offered, during which the company cannot call the bond. This provides the bondholder with a guaranteed length of time he/she will be able to hold the bond. Next, call provisions also specify the price at which the company must buy the bonds back from the bondholders, should it choose to call the issue. This price is usually set at the bond's par value plus a small premium.

Given the structure of call provisions, firms generally call bonds in situations where interest rates have declined since the bonds were first issued. Why? Because they can then buy back their debt at about par value (which will be lower than market value when interest has fallen) and refinance their debt at lower interest rates. Generally, the investor would prefer to hold on to his/her bond, or at least sell it at the higher market price; unfortunately, once a bond issue is called, the investor must accept the call price specified in the bond's indenture. Primarily for this reason, bond investors generally do not like call provisions. However, most bond issues do contain call provisions because most companies receive strong value from them, as they allow a firm to refinance at lower interest rates when they are available.

Generally, callable bonds offer slightly higher interest rates than non-callable bonds as consideration for this flexibility.

(For further reading, see Call Features: Don't Get Caught Off Guard.)

RELATED FAQS
  1. 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 >>
  2. What are the risks of investing in a bond?

    The most well-known risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates ... Read Answer >>
  3. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
Related Articles
  1. Investing

    Bond Call Features: Don't Get Caught Off Guard

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

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  3. 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.
  4. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  5. Investing

    Guide To Embedded Options In Bonds

    Investors should be aware of embedded options that may be available in certain securities as these options may affect the value of the security.
  6. Investing

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  7. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  8. Financial Advisor

    Corporate High-Yield Bonds vs. Equities

    Equities and corporate bonds often play a significant role regarding the diversification of an investor's portfolio. We put both asset classes in contrast.
RELATED TERMS
  1. Callable Bond

    A callable bond is a bond that can be redeemed by the issuer ...
  2. American Callable Bond

    A bond that can be redeemed by the issuer at any time prior to ...
  3. Bond

    A bond is a fixed income investment in which an investor loans ...
  4. Call Privilege

    The provision in a bond indenture that gives the bond issuer ...
  5. Hard Call Protection

    The period in the life of a callable bond during which the issuing ...
  6. European Callable Bond

    A bond that can be redeemed by the issuer at a predetermined ...
Hot Definitions
  1. Asset Allocation

    An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's ...
  2. IRR Rule

    A measure for evaluating whether to proceed with a project or investment. The IRR rule states that if the internal rate of ...
  3. Short Covering

    Short covering is buying back borrowed securities in order to close an open short position.
  4. Covariance

    A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns ...
  5. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  6. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
Trading Center