What Is a Callable Bond?

What Is a Callable Bond?

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

A callable bond is a unique type of bond, issued by corporations or government agencies, which provides the issuer the right to call back, or pay off, the bond before the maturity date. Usually, issuers take advantage of this right when interest rates fall significantly below the bond’s coupon rate. In doing so, the issuer can redeem the existing high-interest bonds, then reissue new bonds at the current lower interest rates. This significantly reduces the cost of borrowing for the issuer. It’s a win for the issuer, but not so much for bondholders. If bondholders receive their principal back before the maturity date, they’ll need to reinvest it, often at the lower prevailing interest rates.

Related Questions

1. What’s the main disadvantage of callable bonds for investors?

For investors, the chief downside of callable bonds is the uncertainty of their income stream. Since the issuer can call back the bond before the preset maturity date, the investor might have to reinvest their returned principal at lower interest rates.

2. What is a non-callable bond?

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A non-callable bond refers to a bond that cannot be redeemed before its maturity date. This bond guarantees that the investor keeps receiving interest until the bond matures, offering stability and predictability for the bondholder.

3. How can you identify a callable bond?

The callable feature of a bond is usually clearly stated in its prospectus, outlining the conditions under which the bond can be called, and any call premium associated with it.

4. Is there any benefit to investors in buying callable bonds?

Yes, there are advantages. Usually, callable bonds offer a higher yield than non-callable bonds. This higher yield can offset the risk of the bond being called before maturity.

5. What does “call premium” refer to?

A call premium is an extra amount over the par value that the issuer pays to the bondholder in the event that the bond is called before maturity. This is to compensate the bondholder for the risk of having their bond called early.