A callable bond (also called redeemable bond) is a type of
bond (debt
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) that allows the
issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity. In other words, on the call date(s), the issuer has the right, but not the obligation, to buy back the bonds from the bond holders at a
defined call price. Technically speaking, the bonds are not really bought and held by the issuer but are instead cancelled immediately.
The call price will usually exceed the
par or issue price. In certain cases, mainly in the
high-yield debt market, there can be a substantial call premium.
Thus, the issuer has an
option
Option or Options may refer to:
Computing
*Option key, a key on Apple computer keyboards
*Option type, a polymorphic data type in programming languages
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...
which it pays for by offering a higher
coupon
In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product.
Customarily, coupons are issued by manufacturers of consumer packaged goods
or by retailers, to be used in re ...
rate. If interest rates in the market have gone down by the time of the call date, the issuer will be able to
refinance its debt at a cheaper level and so will be incentivized to call the bonds it originally issued. Another way to look at this interplay is that, as interest rates go down, the present values of the bonds go up; therefore, it is advantageous to buy the bonds back at
par value.
With a callable bond, investors have the benefit of a higher
coupon
In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product.
Customarily, coupons are issued by manufacturers of consumer packaged goods
or by retailers, to be used in re ...
than they would have had with a non-callable bond. On the other hand, if interest rates fall, the bonds will likely be called and they can only invest at the lower rate. This is comparable to selling (writing) an option — the option writer gets a premium up front, but has a downside if the option is exercised.
The largest market for callable bonds is that of issues from government sponsored entities. They own many