What Is Partial Redemption?
Partial redemption is a retirement or payment of a portion of a callable (or redeemable) bond before its maturity date. Call (or prepayment) provisions govern how early redemptions, whether whole or partial, are handled.
Partial Redemption Explained
Callable bonds are typical of corporate and municipal issuers who wish to have the option to pay off their debt if interest rates drop below the rates on their outstanding bonds. Redeeming the bonds and issuing new bonds at lower rates will save money on interest expenses. In exchange for the possibility that the bond could get called away, the bond investor will receive a slightly higher interest rate compared to a similar non-callable bond. When an issuer calls its bonds, investors receive the call price and any accrued interest to date. The bonds are often called at par value, but sometimes they are called at a premium to par. The call premium is another form of compensation to the investor who now must reinvest in a lower interest rate environment.
Partial Redemption Process
In general, bond investors want to keep their higher-yielding bonds when interest rates decline. When their bonds are called, they expect to be treated fairly and not singled out to give them up. According to Financial Industry Regulatory Authority (FINRA) Rule 4340, a financial institution that controls callable bonds on behalf of clients must establish and make available on its website procedures by which it will allocate among its customers, on a fair and impartial basis, the securities to be redeemed or selected as called in the event of a partial redemption.
Furthermore, if the redemption is favorable (call price above the current price of the bond), no affiliated party of the financial institution can be included in the allocation pool until all clients' positions have been satisfied. If the redemption is unfavorable, no affiliated party can be excluded from the pool. Though not mandated by FINRA, a lottery process is the preferred method for allocation, as it is considered fair and impartial.