Define: Callable Bond

A callable bond is a type of bond that allows the issuer to redeem or “call” the bond before its maturity date. This gives the issuer the option to repay the bond early, usually when interest rates have fallen, in order to save on interest payments.

When a bond is callable, the issuer has the right to buy back the bond from the bondholder at a predetermined price, known as the call price. This typically occurs after a specified call protection period, during which the bond cannot be called. The bondholder receives the call price and any accrued interest if the bond is called.

For issuers, callable bonds provide flexibility in managing their debt obligations. If interest rates decline, the issuer can call the bond and refinance at a lower rate, reducing interest expenses. Callable bonds also tend to offer higher yields to compensate investors for the risk of early redemption.

The main disadvantage for bondholders is the risk of early redemption. If interest rates fall, the issuer is more likely to call the bond, leaving the bondholder with the return of principal and potentially reinvesting at a lower interest rate. This can result in lower overall returns for bondholders.

No, callable bonds typically have a call protection period during which the bond cannot be called. This period is specified in the bond’s terms and conditions and can range from a few years to the entire bond’s duration.

The call price is usually set at a premium to the bond’s face value, known as the call premium. It is determined by the issuer and specified in the bond’s terms. The call premium compensates bondholders for the early redemption and potential loss of future interest payments.

Callable bonds generally carry more risk for bondholders compared to non-callable bonds. The risk lies in the potential for early redemption, which can result in lower returns if interest rates decline. However, callable bonds often offer higher yields to compensate for this risk.

No, once a bond is issued as callable, it cannot be converted into a non-callable bond. The callable feature is determined at the time of issuance and remains throughout the bond’s life.

Callable bonds may have tax implications for bondholders. If a bond is called and the bondholder receives a call premium, it may be subject to different tax treatment compared to regular interest payments. It is advisable to consult with a tax professional for specific guidance on the tax implications of callable bonds.