Definition
A redeemable bond, also known as a callable bond, is a bond that can be redeemed (repaid) by the issuer before its stated maturity date. This feature gives the issuer the flexibility to refinance the debt if interest rates drop or if the issuer’s credit improves, allowing them to re-issue the debt at a lower interest cost. Because of the increased risk to the bondholders due to the possibility of early redemption, callable bonds typically offer higher coupon rates compared to non-callable bonds.
Examples
Corporate Callable Bond: A company issues a 10-year callable bond with a call option after five years at par value. If interest rates decline significantly within five years, the company might call the bond and issue a new one at a lower interest rate.
Municipal Callable Bond: A city government issues a 20-year municipal bond that is callable after 10 years. If the municipality’s credit rating improves or if interest rates decrease, the city can redeem the bond early and reduce its borrowing costs.
Frequently Asked Questions (FAQs)
What is the primary advantage of redeemable bonds for issuers?
The primary advantage is flexibility. Issuers can refinance debt at lower interest rates if market conditions become favorable, reducing their overall cost of borrowing.
How does a redeemable bond differ from a non-callable bond?
A redeemable bond can be repaid before the maturity date at the issuer’s discretion, while a non-callable bond cannot be repaid before its maturity except in special circumstances like default.
What risk do investors face with redeemable bonds?
Investors face reinvestment risk, meaning if the bond is called, they might not be able to reinvest the proceeds at a similar interest rate.
How is the call price usually determined?
The call price is typically set at a premium to the bond’s face value (par), often outlined in the bond’s indenture at issuance.
Are redeemable bonds good for retirement portfolios?
They can be, but investors should consider the reinvestment risk and the higher yields offered as a trade-off for the call feature.
Related Terms
- Coupon Rate: The annual interest rate paid on a bond.
- Maturity Date: The date on which the bond’s principal is repaid to the bondholder.
- Par Value: The face value of a bond.
- Reinvestment Risk: The risk that income from the bond might have to be reinvested at a lower interest rate if the bond is called.
Online Resources
Suggested Books for Further Study
- “The Bond Book” by Annette Thau - A comprehensive guide to bond investing.
- “Investing in Bonds For Dummies” by Russell Wild - A beginner’s guide to investing in bonds.
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi - Detailed analysis and strategies for bond market investing.
Fundamentals of Redeemable Bonds: Finance Basics Quiz
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