Callable Bond

Published Aug 4, 2023

Definition of Callable Bond

A callable bond is a type of bond that allows the issuer to redeem the bond before its maturity date. That means the issuer can buy back the bond from the bondholder at a predetermined price. This feature is usually included in the bond’s indenture and is referred to as the call provision.

Example

To illustrate this, let’s look at a callable bond issued by ABC Corporation. The bond has a face value of $1,000 and a coupon rate of 5%. The bond’s indenture states that the bond can be called at any time after five years at a price of $1,050. That means ABC Corporation can buy back the bond from the bondholder at any time after five years for $1,050.

Now, let’s assume that ABC Corporation decides to call the bond after five years. In that case, the bondholder will receive $1,050 for the bond, which is $50 more than the face value of $1,000. However, if the bond is not called, the bondholder will receive the full face value of $1,000 plus the coupon payments until the bond matures.

Why Callable Bonds Matter

Callable bonds are an important tool for issuers to manage their debt. That means they can use the call provision to reduce their debt burden if interest rates decline. In addition, callable bonds can also be used to increase the issuer’s flexibility when it comes to refinancing their debt.

Furthermore, callable bonds can be used to reduce the issuer’s exposure to interest rate risk. That means the issuer can call the bond if interest rates rise and replace it with a new bond with a lower coupon rate.