Callable Bond

Callable bonds give issuers the right, but not obligation, to redeem bonds before maturity at predetermined prices. Companies typically call bonds when interest rates fall, allowing them to refinance at lower rates. For example, a company that issued 10-year bonds at 6% might call them after 5 years if rates drop to 4%, then reissue at the lower rate. Call provisions usually include call protection periods (e.g., non-callable for first 5 years) and call premiums (paying above par value). Callable bonds trade at lower prices (higher yields) than non-callable bonds due to call risk – the risk of early redemption when rates fall. This creates negative convexity at low yields as price appreciation is capped at the call price. Investors demand 20-50 basis points additional yield for call risk. Most corporate bonds are callable, while Treasury securities are non-callable. Call provisions must be clearly disclosed in bond indentures.