callable bond
A bond that can be redeemed by the issuer before maturity at a predetermined price, typically exercised when interest rates fall and the issuer can refinance at lower rates.
Example
“The callable bond paid a higher coupon to compensate investors for reinvestment risk — the company might refinance when rates fell.”
Memory Tip
CALLABLE bond = issuer can pay it back early. Good for issuer, bad for investor when rates fall.
Why It Matters
Callable bonds matter because they affect the returns you can expect from your bond investments. As an investor, you need to understand that your high-yielding bond could be taken away from you when interest rates drop, forcing you to reinvest at lower rates and potentially disrupting your income strategy.
Common Misconception
Many investors mistakenly believe that callable bonds offer the same guaranteed returns as regular bonds until maturity. In reality, the issuer has the right to call the bond early, which means you could lose the opportunity to earn the higher interest rate you originally purchased the bond for.
In Practice
Suppose you buy a callable bond issued by a corporation with a 5 percent coupon rate and a 10-year maturity, but it can be called after 5 years at $1,050. If interest rates fall to 2 percent after 5 years, the company will likely call the bond so they can refinance at the lower rate, and you will receive $1,050 instead of continuing to earn 5 percent for the remaining 5 years.
Etymology
CALLABLE (able to be called, redeemed early) BOND. A BOND that can be CALLED (redeemed) by the issuer.
Common Misspellings
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