Callable bond: the essence of the financial instrument and its advantages
A callable bond is a type of security that gives the issuer the right to retain the right to redeem. This can be done at any time prior to the maturity date specified in the agreement. Callable bonds have guidelines that outline situations where early redemption is allowed. In addition, they fix the earliest date when redemption is allowed, before this date it is not possible to conduct the operation. It should be noted that the value of this type of securities is less than that of instruments without a call option.
Redeemable bonds are subject to the rule that the investor must receive all the interest that has accrued from the period when the paper was purchased until revocation. This applies regardless of what the reason for the revocation was. The interest rate in this case will be higher than the face value. The latter condition was adopted to compensate the investor for the profit lost due to early redemption.
Early buyback is the exception rather than the rule. Most often, this situation arises as a result of changes in the economy, such as a decrease in the interest rate. In this case, the company recalls all the bonds and redeems them, and then issues new bonds at the changed rate.A bond is a profitable instrument for an investor, even though it can be redeemed early. This is explained by the fact that the redemption of revocable securities has a higher cost than standard ones. And even if a 20-year bond is revoked in 10 years, the loss to the investor will be negligible.
Callable bonds are the most popular in the U.S. market. They occupy a share of 83% of the total number of corporate securities. In addition to this type, there are other instruments for the investor, for example, bonds on which it is necessary to organize a redemption fund. Funds from it are used to reimburse a portion of the annual debt. This process can be carried out in two ways. If the value on the secondary market is less than the face value, then the issuer redeems a certain portion of the bonds. If, on the contrary, the value is higher, then it is allowed to redeem a certain amount at par. In order to determine which securities can be redeemed in this way, a special lottery is held.
Another type is bonds with a put option or a right to early redemption. They differ from callable bonds in that the investor has the right to redeem the securities early, but this is only available during certain periods. These bonds are practically not used in countries with developed economies, but in countries with high investment risk they are quite popular.