What is a Callable Bond?

A callable bond is a type of debt security that allows the issuer of the bond to retain the privilege of redeeming it at some point before the bond reaches the date of maturity. Generally, the terms of the callable bond will include guidelines of what types of conditions must exist before the callable bond is considered eligible for early redemption. The terms and conditions also often specify a call date that is considered to be the earliest possible date that the bond issuer can buy back the bonds at the call price. Callable bonds are less expensive than non-callable bonds of the same coupon value because the callable bonds can be called before they mature, which allows the issuer to pay out a smaller amount.

Sometimes referred to as redeemable bonds, callable bonds tend to include provisions that ensure that, in the event of a call date being exercised, the investor will receive all interest that is due up to the date that the call is issued. Along with honoring the rate of interest guaranteed for the duration for the bond, the issuer also usually honors a rate that is slightly above the par and applies it to the interest due. This usually helps to offset the difference between the interest generated up to the call date and the amount of interest that would have accrued if the bond had continued until the original maturity date.

There is no guarantee that a callable bond will be called before the actual maturity date. Generally, bonds of this type are not called unless economic conditions indicate that an early call is in the best interests of the issuer. For example, the call date option might be exercised if there is a decrease in the interest rate that was applied to the original bond. Under these conditions, it is advantageous for the issuer to recall all bonds, pay them off, then issue new bonds at the lower rate of interest.

For the investor, a callable bond is still considered to be a good investment, even with the chance of an early call date. This is because the callable bond tends to have a higher coupon value than non-callable bonds. Therefore, even in the event that a 20-year bond is called after 10 years, for example, the investor still is likely to realize a higher return than with other types of bonds.