Callable or Redeemable Bonds
Redeemable bonds are bonds that may be retired prior to their maturity dates, either by the issuer or the investor. Bonds are redeemed at a price specified in each bond (usually its face value), together with accrued interest. Their redemption may be optional or mandatory. We will focus on redeemable bonds that give the issuer, rather than the investor, the right or obligation to redeem some or all of a bond issue. This kind of redeemable bond 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 oc