Callable or Redeemable Bonds
When the issuer has the right or obligation to redeem all or a portion of a bond issue, it is known as a callable bond.
An optional redemption allows the issuer to redeem the bonds early, at its option, often at a premium. This callable right may only be exercised at specified times, usually after a certain period of years has elapsed. Issuers will generally choose to redeem a callable bond when current interest rates drop below the bond’s coupon rate. Similar to refinancing the mortgage on a house, the issuer will save money by paying off the bond and issuing another bond at a lower interest rate. Remember, this is called a bond refunding.
With a mandatory redemption, a bond issuer is required to redeem all or a portion of its outstanding issues prior to maturity. Some types of mandatory redemptions occur on a scheduled basis. Bonds are redeemed at a specified price, usually at par, plus interest accrued prior to the redemption date. Other mandatory redemptions occur when a specified amount of money is acquired in a sinking fund. These are known as sinking fund redemptions. A sinking fund redemption requires the issuer to set money aside regularly in a reserve account for the redemption of the bonds before maturity.