What Is a Call Premium?

What Is a Call Premium?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A call premium is an extra amount paid by a bond issuer to bondholders. It’s typically given when the bond issuer requests for early redemption, before the agreed maturing date. Bond issuers may decide to call their bonds if there is a noticeable decline in interest rates. The call premium would be the bond issuer’s compensation to the bondholder for the instability that the early redemption may result in, and it’s usually an amount above the bond’s par value.

Related Questions

1. How is a call premium determined?

The amount of the call premium is determined by the bond issuer at the initial stage. It’s mentioned in the bond agreement and usually depends on the bond’s coupon rate, the remaining bond term before maturity, and market interest rates.

2. What does “call risk” mean in bond investing?

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Call risk is the risk faced by bond investors that a bond might be repurchased by the issuer before its maturity date. This generally occurs when interest rates drop, and the issuer can issue new bonds at a lower rate. The investor now has to reinvest the returned capital at lower prevailing rates, and may be on the losing end if they initially bought the bond at a premium.

3. What is the difference between a call premium and call price?

The call premium refers to the amount over and above the bond’s face value that the issuer pays to the bondholder for the early redemption. On the other hand, the call price consists of the bond’s face value plus the call premium.

4. What happens when a bond is called?

When a bond is called, the issuer pays back the principal and any accrued interest to the bond holder and effectively retires the bond earlier than its maturity date. This is often accompanied by a call premium.

5. What is an example of a callable bond?

Corporate bonds are often callable. For example, a company may issue a 10-year bond with a 5% interest rate. However, if interest rates decrease to 3% after 5 years, the company may opt to call the bond, pay the investors the call premium, and then reissue the bond at the lower 3% rate, saving on their interest payment costs.