What is calling a bond

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Develop and improve products. List of Partners vendors. A callable bond, also known as a redeemable bond, is a bond that the issuer may redeem before it reaches the stated maturity date.

A callable bond allows the issuing company to pay off their debt early. A business may choose to call their bond if market interest rates move lower, which will allow them to re-borrow at a more beneficial rate. Callable bonds thus compensate investors for that potentiality as they typically offer a more attractive interest rate or coupon rate due to their callable nature.

A callable bond is a debt instrument in which the issuer reserves the right to return the investor's principal and stop interest payments before the bond's maturity date. Corporations may issue bonds to fund expansion or to pay off other loans.

If they expect market interest rates to fall, they may issue the bond as callable, allowing them to make an early redemption and secure other financings at a lowered rate.

The bond's offering will specify the terms of when the company may recall the note. A callable—redeemable—bond is typically called at a value that is slightly above the par value of the debt.

The earlier in a bond's life span that it is called, the higher its call value will be. For example, a bond maturing in can be called in It may show a callable price of The bond may also stipulate that the early call price goes down to after a year. Callable bonds come with many variations. Optional redemption lets an issuer redeem its bonds according to the terms when the bond was issued.

However, not all bonds are callable. Treasury bonds and Treasury notes are non-callable, although there are a few exceptions. Most municipal bonds and some corporate bonds are callable. A municipal bond has call features that may be exercised after a set period such as 10 years. Sinking fund redemption requires the issuer to adhere to a set schedule while redeeming a portion or all of its debt.

Call features can be found in corporate, municipal and government issues as well as CDs. Preferred stocks can also contain call provisions.

Let's look at an example to see how a call provision can cause a loss. This results in an 8. Suppose that three years go by, and you're happily collecting the higher interest rate.

Then, the borrower decides to retire the bond. Plus, once the bond is called, your loss is locked in. When you are buying a bond on the secondary market , it's important to understand any call features, which your broker is required to disclose in writing when transacting a bond.

Usually call provisions can be inspected in the issue's indenture. When analyzing callable bonds, one bond isn't necessarily more or less likely to be called than another of similar quality. You would be misinformed to think only corporate bonds can be called.

Municipal bonds can be called too. The main factor that causes an issuer to call its bonds is interest rates.

One feature, however, that you want to look for in a callable bond is call protection. This means there's a period during which the bond cannot be called, allowing you to enjoy the coupons regardless of interest rate movements.

Before buying a callable bond, it's also important to make sure that it, in fact, offers a higher potential yield. Find bonds that are non-callable and compare their yields to callable ones. However, locating bonds without call features might not be easy, as the vast majority tend to be callable. If you own a callable bond, remain aware of its status so that, if it gets called, you can immediately decide how to invest the proceeds.

To find out if your bond has been called, you will need the issuer's name or the bond's CUSIP number. Then you can check with your broker or a number of online publishers.

Finally, don't get confused by the term "escrow to maturity. This term simply means that a sufficient amount of funds, usually in the form of direct U. Any existing features for calling in bonds prior to maturity may still apply. As we mentioned above, the main reason a bond is called is a drop in interest rates. At such a time, issuers evaluate their outstanding loans, including bonds, and consider ways to cut costs.

If they feel it is advantageous for them to retire their current bonds and secure a lower rate by issuing new bonds, they may go ahead and call their bonds. At such a time, you as a bondholder should examine your portfolio to prepare for the possibility of losing that high-yielding asset. Many municipal bonds, for example, have optional call features that issuers may exercise after a certain number of years, often 10 years.

Sinking Fund Redemption. Requires the issuer to regularly redeem a fixed portion or all of the bonds in accordance with a fixed schedule. Extraordinary Redemption. Allows the issuer to call its bonds before maturity if certain specified events occur, such as the project for which the bond was issued to finance has been damaged or destroyed.

Featured Content. Site Information SEC. As a result, callable bonds often have a higher annual return to compensate for the risk that the bonds might be called early. Callable bonds typically pay a higher coupon or interest rate to investors than non-callable bonds. The companies that issue these products benefit as well. Should the market interest rate fall lower than the rate being paid to the bondholders, the business may call the note.

Start-up businesses have a high failure rate when compared with larger, well-established firms. Consequently, small companies typically have to pay higher rates on loans and bonds than more established firms. This phenomenon is called price compression and is an integral aspect of how callable bonds behave. An issuer may choose to call a bond when current interest rates drop below the interest rate on the bond.

That way the issuer can save money by paying off the bond and issuing another bond at a lower interest rate. This is similar to refinancing the mortgage on your house so you can make lower monthly payments. As a result, a callable bond may not be appropriate for investors seeking stable income and predictable returns.

Callable bonds offer one tool to marginally enhance the rate of return over your overall fixed-income portfolio, but they do so with additional risk and represent a bet against lower interest rates.

Those appealing short-term yields, can end up costing you in the long run. Bonds are loan agreements involving creditors and borrowers.