Definition: A feature of a bond that allows the corporation which issued it to require that it be turned in by current holders for payment of its loan amount (ie, face value) before its scheduled due (ie, maturity) date.
Example: BECD Corporation issues a 20-year, 8% bond that has a call provision. After a call protection period of 10 years, the bonds become callable. By this time, the interest rates being paid by comparable corporations on the new bonds they issue has fallen to 6%. BECD can save money by issuing new bonds paying 6% interest and using the money to call its older bonds on which it is paying investors 8% interest.
Investeach explains: A call provision gives corporations a valuable option. Conversely, it represents a risk for bond investors. They may be counting on being able to collect a nice, high interest rate until the bonds mature, only to be surprised when the company calls the bonds years before that date. In order to recognize the value to the corporation and risk to the investor, callable bonds pay a higher than normal interest rate.
When a bond is called early, corporations recognize that they are inconveniencing their bond investors. To lessen the blow, they pay a call premium, an amount over and above the face value. The value of the premium may start at one year’s interest in the first year the bond is callable, and then decline to zero as the maturity date approaches.
Riddle me this:
1. In your own words, what does a call provision allow a corporation to do?
2. Identify a situation in which a corporation would want to call it’s bonds.
3. In what way can owning a bond with a call provision disappoint an investor?
4. Are callable bond rates higher or lower than those paid on non-callable bonds, and why?
Also known as: Callable bond.