Callable

A callable security can be redeemed by the issuer before its scheduled maturity date, usually triggering a necessity for extra payment to the holder, identified as a call premium.
On this page

Definition

Callable refers to a feature in certain securities, most commonly bonds, that allows the issuer to redeem the security before its scheduled maturity date. When a security is called, the issuer pays the holders a premium price, known as a call premium. Issuers typically call bonds when interest rates have fallen, allowing them to issue new bonds at a lower interest rate and economize on interest payments.

Examples

  1. Callable Bonds: A company issues 30-year bonds with a callable feature after 10 years. If interest rates drop significantly in those 10 years, the company can call the bonds, pay off the holders with a call premium, and reissue new bonds at the current lower interest rates.

  2. Mortgage-Backed Securities (MBS): A MBS may also have a callable feature. If homeowners prepay their mortgages due to refinancing at lower rates, the MBS could be called, returning principal to investors alongside a potential premium.

Frequently Asked Questions (FAQs)

1. Why would an issuer want to call a bond?

Issuers call bonds to take advantage of lower interest rates, thus saving on interest payments by refinancing the debt at a reduced rate.

2. What is a call premium?

A call premium is the extra amount over the face value that issuers pay bondholders when the bond is called before maturity. This acts as compensation for the early redemption.

3. Are callable bonds more risky for investors?

Yes, because if a bond is called, the investor may be forced to reinvest the principal at a lower interest rate, leading to a potential decrease in total returns.

4. How is the call price determined?

The call price is typically set at issuance and includes the face value of the security plus a call premium.

5. Can all bonds be called?

No, only bonds and securities issued with an explicit callable feature can be called by the issuer before the end of the maturity period.

  • Call Premium: The additional amount paid by the issuer over the bond’s face value when the bond is called early.
  • Call Price: The total amount (face value plus call premium) paid to the bondholder by the issuer upon calling the bond before its maturity.
  • Convertible Bond: A bond that can be converted into a predefined amount of the issuer’s equity at certain times during the bond’s life.

Online References

  1. Investopedia on Callable Bonds
  2. Wikipedia on Callable Bonds
  3. Securities and Exchange Commission (SEC) definition of Callable Bonds

Suggested Books for Further Studies

  1. The Bond Book by Annette Thau - A comprehensive guide to understanding bonds.
  2. Fixed Income Securities: Tools for Today’s Markets by Bruce Tuckman and Angel Serrat.
  3. Investing in Bonds For Dummies by Russell Wild - An easy-to-understand primer on bond investing.

Fundamentals of Callable: Finance Basics Quiz

Loading quiz…

Thank you for studying the concept of callable securities with our comprehensive guide and engaging quiz! Keep enhancing your financial literacy for greater investment acumen!

Callable Bonds
Call Waiting