Definition:
Callable bonds are bonds that the issuer has the option to redeem or call back before their maturity date. This means the issuer can repurchase the bonds from the bondholders at a predetermined price.
Key characteristics of callable bonds:
- Call provision: The issuer has the right to call the bonds.
- Call price: The price at which the issuer can call the bonds.
- Call premium: The call price is typically at a premium to the face value of the bond.
- Investor risk: Callable bonds carry the risk that the issuer may call them early, limiting the potential return for investors.
Why do issuers issue callable bonds?
- Lower interest rates: If interest rates decline after a bond is issued, the issuer may call the bond and reissue new bonds at a lower interest rate.
- Flexibility: Callable bonds provide the issuer with flexibility to refinance their debt.
Why do investors buy callable bonds?
- Higher yield: Callable bonds often offer a higher yield than non-callable bonds to compensate investors for the call risk.
- Early redemption: Investors may benefit from early redemption if interest rates decline and the issuer calls the bonds.
However, it’s important to note that callable bonds carry the risk of early redemption, which can limit the potential return for investors.
In essence, callable bonds are bonds that the issuer has the option to redeem early, and they offer investors a higher yield but also carry the risk of early redemption.
