Callable bond

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A callable bond (also called redeemable bond ) is a type of bond (debt security) that allows a bond issuer to retain the privilege of redeeming a bond at some point before the bond reaches its maturity date. In other words, on the date of the call, the issuer has the right, but not the obligation, to repurchase the bonds from the bondholder at a specified call price. Technically, the bonds are not actually bought and held by the publisher but are otherwise canceled immediately.

Call prices will usually exceed the nominal price or issue. In certain cases, especially in high-yielding debt markets, there can be substantial call premiums.

Accordingly, the publisher has a pay option by offering a higher coupon rate. If the interest rate on the market has dropped by the date of the call, the issuer will be able to refinance its debt at a cheaper rate and thus will be given an incentive to call the bonds originally issued. Another way to see this interaction is, when interest rates go down, bond prices rise; therefore, it is advantageous to buy bonds back at face value.

With callable bonds, investors have the benefit of higher coupons than they have with non-callable bonds. On the other hand, if interest rates fall, bonds are likely to be called and they can only invest at a lower rate. This is comparable to selling (writing) an option - the author of the option gets the premium up front, but has a negative side if the option is exercised.

The biggest market for callable bonds is the issues of government sponsored entities. They have lots of mortgages and mortgage-backed securities. In the US, mortgages are usually fixed interest, and can be paid upfront at no cost, in contrast to norms in other countries. If prices fall, many homeowners will refinance at a lower rate. As a result, agencies lose assets. By issuing a large number of callable bonds, they have a natural fence, as they can then call their own problems and refinance at a lower rate.

The price behavior of a callable bond is the opposite of a puttable bond. Since call and put option options are not mutually exclusive, the bond may have both embedded options.

Video Callable bond

Pricing

Callable bond price = Bond price straight - Call option price ;

• Callable bond prices are always lower than the straight bond price because the call option adds value to the publisher.
• The yield on a callable bond is higher than the yield on a straight bond.

Maps Callable bond

References

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External links

• 2000 Bond
• Callable Bond: Definitions

Source of the article : Wikipedia