Callable Bonds
Callable Bonds are common and allow the issuer to retire the bond before the maturity date.
Callable bonds are bonds that the issuer can call (i.e. buy back) before the maturity.
The terms of the provision (i.e. when the bonds can be called back and at what price) is specified in the indenture.
In general the call provision does not apply to the first few years of the bonds life during this time the bond is said to be call protected.
Given that this option to valuable for issuers (because they exercise it only when they can replace the outstanding bonds by new bonds with a lower interest rate), these bonds pay a higher interest rate than normal bonds.
Callable means the issuer has the right to force the redemption of the bonds before they mature.
Given a choice (and everything else being equal) an investor would always choose a non callable bond because they offer more certainty and potentially higher returns if interest rates decline.
Callable Bonds - The issuer can redeem the bond at a stated earlier date if they choose to. The investor is compensated by a higher coupon.
Call provisions are outlined in the bond's prospectus and the indenture
Both are documents that explain the terms and conditions
Before you buy a bond you should always check to see if the bond has a call provision.
Some bonds can be callable once a year.
In this case the call premium declines as each call date passes without a call.
If a bond is called before the maturity date then the rate of return will obviously be different to the yield to maturity.
When a bond is called we add the call premium to the face value
Whether the bond is called or not will depend on which is cheaper for the issuer.
This still relies on reinvesting at the YTC rate
A callable (or redemable) bond gives the issuer the right to buy back all (or some) of the issue prior to the stated maturity date
The bonds are redeemable either at par or a higher price
These are particularly popular with corporate and municipal bond issues in the US
Call features may provide for the following:
optional redemption
extraordinary redemption (if certain conditions / specified events)
sinking fund redemption (required to redeem. Some bonds on a periodic basis
Generally incrporate a non-callable (or lock out) period
Yields are generally higher than equivalent non-callable
bonds can also be issued with put provisions attached
Call Schedule
Callable bonds usually have a call schedule in which a decreasing premium is paid to the buyer to compensate for the additional risk.
Yield to Call
This is a simple variation on Yield to Maturity.
Issuers 'call' bonds to lower funding costs.
Callable bonds usually have a 'call schedule' in which a 'decreasing' premium is paid to the buyer to compensate for the 'call risk'.
SS equation
Calculated exactly the same way as the Yield to Maturity except that instead of using the maturity date you use the call date and the bond's call price
Often abbreviated to YTC.
This is the IRR on the bonds cash flow, assuming it is called at the first opportunity instead of being held till maturity.
Bond issuers normally offer a call premium as an incentive.
A call premium (a percentage of the face value) is in additional to the face value that must be paid in the event that the bond is called before it matures.
Important
A lot of high yield bonds are callable
© 2024 Better Solutions Limited. All Rights Reserved. © 2024 Better Solutions Limited TopPrevNext