Callable Bond

A callable bond is a bond that gives issuer the right but not the obligation to redeem the bond prior to its maturity. When an issuer call its bonds, it pays investor the call price (face value of the bond + call premium) together with accrued interest at that point. A company will often call a bond if it is paying a higher coupon than the current market interest rates since they can reissue the same bonds at lower interest rate. Hence, callable bonds are traded at a discount to their non-callable counterparts since they are of a greater value to the issuer. Callable bonds also come with call protection, which means that before a defined period the bonds cannot be called.

For example, suppose a company issued a $100 par, 20-year callable bonds with a coupon rate of 6% and a call price of $102.  The call protection of these bonds is five years which implies that issuer cannot recall the bonds within the first five years. If the market interest rate after these 5 years is less than 6%, say 4%, the bonds will trade at a premium to par. If the bonds are trading at $103 i.e. greater than the call price, the issuer will call the bonds and reissue them at the latest market interest rates. If the market interest rates are at 5% and the bonds are trading at $101, the issuer cannot recall the bonds.