When purchasing a Government or Corporate bond, beware the debt security may have a callable (call date) or redeemable feature: The issuer of the bond may redeem the bond at the face value (sometimes above the face value) or call price, before the date of maturity (the date the face value is repaid and last coupon payment) and, without paying remaining interest on the life (years) of the bond. 1 Callable Bond Call Date specifies a calendar date or any time afterwards, when the issuer of the bond may redeem that bond from the bond holder, and subsequently stop further interest payments. 6 Most callable bonds are issued by government sponsored entities (State & Local Governments) including mortgage backed securities. 2 Advantages and disadvantages for purchasing a callable bond. 3
A callable bond may have a call protection (deferment period or cushion): The investor is protected from the issuer redeeming the bond within a number of years (Typically between two and three years or a minimum number of years 7), from the time the bond was purchased. During this time, the bond holder receives interest paid on the debt security. 3
Local, State, Federal governments and Corporations may issue callable bonds, advantageous to the issuer when interests rates are falling. “An issuer may choose to redeem a callable bond when current interest rates drop below the interest rate on the bond. Thus issuer can save money by paying off the bond and issuing another bond at a lower interest rate (Referred to as refunding 1).” In retrospect: Comparable to a homeowner refinancing a mortgage when interest rates fall. 4
Advantages and Disadvantages buying Callable Bonds: Favorably issuers of callable bonds pay a higher coupon (interest rate paid) compared to non-callable bonds, since the bonds have a risk for being callable before maturity. “The call price will usually exceed the par or issue price.” 2 Unfortunately, when interest rates are falling callable bond holders often have their debt security called or redeemed, saving the issuer money paying future high interest payments. Investors relying upon high interest payments on callable bonds incur a risky investment, if the bond is callable. When a callable bond is purchased above par value (100), the bond – holder incurs a capital loss if the bond is called at par value. 4
References:
1.) Callable Bond – http://www.investorwords.com/671/callable_bond.html
2.) Callable bond – http://en.wikipedia.org/wiki/Callable_bond
3.) Call Protection – http://www.answers.com/topic/call-protection
4.) Callable or Redeemable Bonds – http://www.sec.gov/answers/callablebonds.htm
5.) Knowing the call dates on bonds is critical for investors – http://www.usatoday.com/money/perfi/columnist/krantz/2010-12-29-callable-bonds_N.htm
6.) KYNEX Bulletin – October 2009 – https://www.kynex.com/Bulletin/Oct2009/StockHistory.htm
7.) call protection – http://www.fxwords.com/c/call-protection.html