What is 'Call Premium'

Call premium is the dollar amount over the par value of a callable debt security that is given to holders when the security is redeemed early by the issuer. The call premium is also called the redemption premium.

In options terminology, the call premium is the amount that the purchaser of a call option must pay to the writer.

BREAKING DOWN 'Call Premium'

Call Premium for Bonds and Preferred Shares

Most corporate bonds and preferred shares have call provisions which permit the security issuer to redeem the securities before they mature. Securities that have this feature are referred to as callable securities. When a bond is callable, the issuer has the right to call in the bonds when interest rates decline in the economy. The existing bonds will be redeemed early and the issuer takes advantage of the attractive lower interest rates in the markets by refinancing its debt issue. In effect, the issuer buys back the higher coupon paying bonds, and reissues bonds with lower coupon rates, effectively reducing the company’s cost of borrowing. While this is favorable to the bond issuer, bondholders are exposed to reinvestment risk – the risk of reinvesting their funds in a lower interest-paying bond. In addition, bonds that are redeemed early stop making interest payments to bondholders. For example, an investor holding a 10-year bond that is called after four years will not receive coupon payments for the remaining six years after the bond is redeemed.

To compensate callable security holders for the reinvestment risk they are exposed to and for depriving them of future interest income, issuers will typically pay a call premium. The call premium is an amount over the face value of the security and is paid in the event that the security is redeemed before the scheduled maturity date. Put another way, the call premium is the difference between the call price of the bond and its stated par value. For noncallable bonds or for a bond redeemed during its call protection period, the call premium is a penalty paid by the issuer to the bondholders.

During the first few years a call is permitted, the premium is generally equal to one year's interest. Depending on the terms of the bond agreement, the call premium gradually declines as the current date approaches the maturity date. At maturity, the call premium s zero.

Call Premium for Options

A call option is a financial contract that gives the buyer the right to purchase the underlying shares at an agreed price. The call premium is the price paid by the buyer to the seller (or writer) to obtain this right. For example, an investor buys a May 18, 2018 call option on AAPL with a strike price of $180. If by May 18, the stock price rises past $180, the investor will exercise his option to purchase 100 shares of AAPL @ $180 each. However, in order to receive the rights associated with a call option, a call premium must be paid to the seller. In this case, the premium for one AAPL 180 call option is $7.60. Therefore, the call writer received $7.60 x 100 shares/contract = $760.

RELATED TERMS
  1. Callable Security

    A callable security is a security with an embedded call provision ...
  2. Call Date

    The call date is the date on which a bond can be redeemed before ...
  3. Call Protection

    A call protection is a protective provision of a callable security ...
  4. Partial Redemption

    Partial redemption is a retirement or payment of a portion of ...
  5. Multi-Callable Bond

    A multi-callable bond allows an issuer to redeem its bonds on ...
  6. Called Away

    Called away is a term for the elimination of a contract before ...
Related Articles
  1. Investing

    Callable Bonds: Leading a Double Life

    Learn the difference between a normal bond and a callable bond. Discover five things you must know before investing and why callable bond lives a double-life that contains so much risks.
  2. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  3. Investing

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
  4. Retirement

    Write Covered Calls To Increase Your IRA Income

    Covered calls may require more attention than bonds or mutual funds, but the payoffs can be worth the trouble.
  5. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  6. Investing

    4 basic things to know about bonds

    Learn the basic lingo of bonds to unveil familiar market dynamics and open to the door to becoming a competent bond investor.
  7. Investing

    Retail Notes: A Simpler Alternative To Bond Funds

    These securities are meant to be held until maturity, removing the burden of complex pricing that sometimes plagues bonds.
  8. Investing

    7 Common Bond-Buying Mistakes

    Find out how to avoid the costly mistakes made in bond portfolios everywhere. Learn to minimize the risk of suffering low or negative returns when trading.
RELATED FAQS
  1. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
  2. What does it mean when a bond has a put option?

    A put option on a bond is a provision that allows the holder of the bond the right to force the issuer to pay back the principal ... Read Answer >>
  3. Which factors most influence fixed-income securities?

    Learn about the main factors that impact the price of fixed-income securities, and understand the various types of risk associated ... Read Answer >>
Trading Center