What is a 'Call Privilege'

A call privilege is the provision in a bond indenture that gives the bond issuer the option to redeem all or part of the bond issue, at pre-determined prices on certain specified dates. These dates are known as call dates and form the call schedule.

BREAKING DOWN 'Call Privilege'

The term call privilege derives its name from the fact that the issuer's option to redeem the bond issue, is akin to a call option on the bonds. Bonds with a call privilege are sometimes referred to as callable bonds. In return for this privilege, the issuer will generally pay a coupon rate that is higher than that paid by straight bonds of comparable maturity and credit quality.

With a call privilege, the pre-determined price at which a bond can be called is generally higher than the par or issue price. This call premium is demanded by investors to justify the risk involved in holding bonds that have call privileges embedded in them. Since an issuer is quite likely to exercise its call privilege when prevailing interest rates are significantly lower than they were at the time the bond was issued, buyers of callable bonds have to deal with reinvestment risk, or the risk of investing bond proceeds at lower interest rates. In the case of bonds that contain call privileges, yield to call may be a better measure of the yields that investors can expect from such bonds, rather than yield to maturity.

Pros and Cons of a Call Privilege

One advantage of the call privilege provision is that it allows the issuer of the bond flexibility. The issuer is permitted to redeem any part, or even all, of the bond issue at pre-determined prices on dates agreed upon ahead of time. By determining the set dates and prices ahead of time, the issuer is protected from future interest rates below the rate at the time of the bond’s issue.

The disadvantage of a call privilege in addition to the reinvestment risk is the relatively higher issue price. With the higher risk of reinvestment, investors generally request a higher call price than other bonds as well as a higher coupon rate for a callable bond than similar bonds of equitable maturity and credit. To help offset the risk and relatively high cost of bonds with call privilege, some issues have a call protection period, a time period that prevents the bond from being called.

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