Callable bond
Alternatively referred to as a 'redeemable bond', it’s a fixed-income instrument that grants its issuer with the right of redeeming the bond and exchanging it for its face value at any moment, even before the date of maturity.
This means that the issuer keeps the right to cover its debt earlier than the date of maturity. This may be a valuable benefit for the issuer, as it allows them to save money on coupon payments.
Alternatively, companies may choose to refinance their debt if the market conditions improve and lower interest rate loans become accessible.
Businesses try to compensate for the uncertainty of keeping the right to ‘redeem’ the bond by offering higher interest or coupon rates. While there exist a few exceptions, Treasury notes and Treasury bonds are generally non-callable.
It is possible to calculate the value of a callable option via the following formula:
Price (Callable bond) = Price (Regular non-callable bond) – Price (Call option)
In the formula:
- Price (regular non-callable bond) equals the price of a non-callable bond that shares similar features with the (callable) bond.
- Price (Call Option) – the price of a call option to redeem the bond before it matures.
