Definition
The call price is the cost at which a bond or a preferred stock can be redeemed or repurchased by the issuer before its maturity date. It’s usually set above the par or face value, providing an incentive for the issuer to call their security if interest rates fall. In other words, it’s the price at which an issuer has the right to pay off its debt early.
Key Takeaways
- The call price, typically specified within a callable bond’s contract, is the price at which a bond issuer can redeem the bond before its maturity date. This price is generally higher than the bond’s face value.
- Issuers may choose to call bonds when market interest rates drop significantly below the bond’s coupon rate, allowing them to refinance their debt at a lower cost. A callable bond hence provides issuers with flexibility in managing their debt.
- While call prices can be beneficial for issuers, they may pose reinvestment risks to bondholders, as they may not be able to reinvest the returned principal at a rate as high as the original bond’s rate.
Importance
The finance term “Call Price” is important because it represents the price at which a bond or a preferred stock can be redeemed by the issuer before its maturity date.
This is crucial for investors as it directly impacts their potential return on investment.
If interest rates decrease, issuers might use their call option to pay off the existing debt and reissue a new bond at a lower rate, saving them money.
Investors need to be aware of the call price to assess the possibility of bonds or preferred shares being called early, which will cease their interest payments and affect their income stream.
Ultimately, the call price is a critical factor in decision-making about buying or holding the security.
Explanation
The primary purpose of a call price is to illustrate the amount that is to be paid by an issuer if they decide to redeem a bond before its maturity date. This is typically higher than the bond’s face or par value to compensate for the bondholder’s loss of potential interest earnings, a repercussion of the early repurchase.
The call price serves as a significant component of callable bonds as it helps determine the potential return on investment. This means investors can utilize this price when evaluating the risks and returns associated with the purchase of a certain bond.
Moreover, the call price is used by bond issuers to manage their debt effectively. If interest rates decrease after a bond is issued, the issuer might choose to call the bond and reissue it at the then lower interest rate.
The call price, therefore, provides a mechanism for the issuer to limit the amount of interest they pay over the life of a bond. Overall, the call price significantly affects the issuer’s redemption strategy and the bondholder’s investment decisions.
Examples of Call Price
Corporate Bonds: In the corporate world, a company might issue bonds with a call price to raise funds for a project. Let’s assume Company XYZ issued 10-year bonds at a 5% interest rate with a call price of $1,
After five years, if the market interest rates drop to 3%, the company might decide to call back the bonds at the call price of $1,
The company can then reissue new bonds at the lower 3% interest rate, thus saving on interest payments.
Callable Preferred Stocks: Like bonds, some stocks also come with a callable feature. For example, a company issues preferred stock with a fixed dividend and a call price of $25 per share. If the company’s earnings increase significantly and it believes it can pay less in dividends, it might decide to call the preferred shares at the call price, eliminating the higher fixed dividend obligation.
Mortgage-Backed Securities (MBS): MBS is another common class of callable securities. These are bundles of home loans sold to investors, and they typically have call options attached to them. If interest rates decrease, homeowners may opt to refinance their mortgages at lower rates. This means the mortgage companies would call the MBS, repaying investors the call price. The mortgage company could then issue new MBS based on the refinanced mortgages, again, at lower rates.
FAQs on Call Price
What is a Call Price?
Call Price refers to the price at which a bond or a preferred stock can be redeemed by the issuer. This price is set at the time of issuance and is often higher than the bond’s par or issue price.
Is the Call Price always higher than issue price?
Generally, the call price is set above the bond’s issue or par price. However, as the bond approaches its call date, the call price gradually declines to match the bond’s par or issue price.
Can bond be redeemed at any time?
Bonds cannot be redeemed at any time. The issuer has the right to repay the bond before its maturity date, but only after a specified call protection period.
What happens when a bond is called?
When a bond is called, the issuer repays the bond at the call price, effectively canceling the bond. This means the bond investors will lose any future interest payments after the call date.
What is the impact of call price on investor?
The call price can affect the yield a bond investor may receive. If a bond is called at a price below the market price, the investor will receive less than what they could have sold it for in the open market. Hence, investors often require a higher yield to compensate for the risk that a bond may be called early.
Related Entrepreneurship Terms
- Bond Premium
- Callable Bonds
- Interest Rates
- Redemption Date
- Yield to Call
Sources for More Information
- Investopedia: Comprehensive resource for investing education, personal finance, market analysis and more.
- Yahoo! Finance: Offers financial news, investing info, personal finance advice, and tools.
- Reuters: International news organization providing important finance information and news.
- Bloomberg: Global business, finance news, market data, analysis, video and more.
