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What are callable bonds, and should your business invest in them?

Callable bonds are bonds in which the issuer has the right to redeem the callable bond prior to its maturity date. Under certain conditions a callable bond can stop paying interest while the bond holder has no choice in the matter.

Bonds are issued by companies or government agencies. When a bond is issued certain guidelines are given in conjunction with how and when the bond will be paid back to the investor. The bond should also explain at what price the bond is to be redeemed at. Investors are interested in bonds because they generally yield a larger percentage rate than if you were to leave your money in a typical savings account. Bonds are also a better guarantee for a return as coupons for the interest amount are sent to the investor or bond holder by the bond issuing entity.


Callable bonds have interest rate pay-outs that are slightly above average. These rates will generally be paid off in increasing amounts the earlier the bond is called. A company will decide to call a bond if it is paying a higher coupon rate than the current market interest rates. Or other words, when they are no longer competitive with market rates because the rates have decreased. Once the company had called a bond they can reissue the same bonds at a lower interest rate. The bond holder can choose to keep the bonds at the lower rate or to sell them. The process that the company goes through to reissue bonds on order to save money on the coupon/interest payments is called "refunding."

Refunding occurs when a callable bond is at their highest point which makes it imprudent for a new investor to look for exceptionally high callable bond rates as they are bound to be refunded.
In some cases the company issuing the bond will have the right to not only call their bonds at the market rate but there are situations when the bond can be called at a rate lower than the standard market rate.

Bond holders are notified by letter if they currently hold bonds that have been called. Part of investing in a callable bond means that you agree to have no say in the matter if your bond is called and you must either choose to sell the bond or to hold on to it even though you will be receiving a lower rate. Companies may also advertise that they are calling their bonds in major financial publications in an attempt to notify bondholders.

One advantage of an investor willing to take the risks of purchasing a callable bond is that there is a type of callable bond protection available where there is a designated period of time during which the bond cannot be called. A bond is called when it is economically beneficial for the issuer not to the bond holders.

The bottom line is that callable bonds offer interest advantages just as do regular bonds, but the bond issuer has the right to pay off the bond if the interest payments rise too far above the agreed rate. The advantage is in the hands of the bond issuer unless the bondholder has the insight and timing to be able to sell their bond to another bond holder before the bond is called.

With sophisticated and dedicated analysis of credit risk, interest rate risk and potential options of a callable bond, investing in callable bonds can be advantageous. However, few investors have the time or resources to do this and those who choose to employ bond dealers to perform these services for them generally make just as much as if they had bough traditional bonds and had not had to pay the dealer's fees.

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