Callable bond

A callable bond is a bond that the issuer can repurchase during certain time periods before its maturity date. To be callable, a bond must have a call feature, which enables the issuer to repurchase the bond before its maturity date. An issuer who chooses to call a bond generally pays the bond’s holder a call premium upon repurchase, which is meant to compensate the holder for the disadvantage of having to find another way to invest his or her money. Issuers like call features for several reasons. First, they can repurchase BONDS with call features and reissue them at a lower interest rate. If INTEREST RATES drop significantly, issuers sometimes need to repurchase and reissue their bonds to refinance their own debts. For example, if a 20- year callable corporate bond is issued at an 11.5-percent interest rate, and after five years interest rates drop to 8.5 percent, the CORPORATION could potentially waste a great deal of money if it did not recall the bond and reissue it at the lower rate. Issuers also sometimes like to recall bonds when they are rearranging their own capital structures or expanding. The flexibility afforded to issuers by the call feature enables them to do this. A bond’s call provision states whether the bond is noncallable, freely callable, or deferred callable. If a bond is noncallable, the issuer cannot repurchase it before the bond’s date of maturity. Noncallable bonds are attractive to some investors because the issuer has to pay interest on them for the bond’s full term, regardless of any prevailing level of interest rate. The drawback to these bonds for some investors, however, is that their interest rates are generally not as high as their callable counterparts. Noncallable bonds are sometimes referred to as bullets. In comparison, an issuer can rescind a bond that is freely callable at any time. These types of bonds offer virtually no protection to investors and can be repurchased after as little as a few days. A bond with a deferred call provision offers more protection to investors than a freely callable bond but less than a noncallable bond. Deferred callable bonds can be repurchased by the issuer, but only after the amount of time specified in the provision—for example, one, two, or 10 years after the date of purchase. The only bonds that cannot be called are ones issued by the federal government. Other bonds, including state, municipal and corporate bonds, can be called when issuers are not able to meet interest rates, according to their own call provisions. Of the major types of bonds, corporate bonds are most likely to be called.