What is the Call Price?
The call price is the amount of money a company pays to investors when it buys back its callable bonds before they mature. Callable bonds are a type of bond that the issuing company can “call” or redeem early. The call price is also known as the redemption price.
How Call Price Works
When a company issues bonds, it borrows money from investors and agrees to pay them back with interest. Most bonds have a set maturity date when the company repays the face value of the bond.
However, some bonds are callable, which means the company has the right to buy them back at a specific price (the call price) before the maturity date. The company has to announce the call in advance, giving investors notice.
The call price is usually higher than the face value of the bond. This call premium compensates investors for the risk that the company could pay back the bond early. For example, if a bond has a $1000 face value, its call price might be $1050.
Why Companies Call Bonds
Companies choose to call their bonds and pay the call price for a few main reasons:
Interest Rates Have Fallen
If market interest rates fall below the rate the company is paying on its existing bonds, it may be cheaper for the company to call those bonds and issue new ones at the lower interest rates. This saves the company money.
Credit Rating Improved
If the company’s financial health and credit rating improve, it may be able to borrow money at lower interest rates than what it is paying on existing bonds. Calling the bonds and reissuing at lower rates makes financial sense.
Clause Requires It
Some bonds have a mandatory redemption clause that requires the company to call the bonds on a certain date or if certain conditions are met, such as the company issuing more debt.
Impacts on Investors
For investors, a bond being called is both good and bad news:
Guaranteed Profit
When bonds are called, investors receive the call price, which is higher than the price they likely paid for the bond. They earn the call premium as profit.
Reinvestment Risk
Although investors make a profit when bonds are called, they lose the remaining interest payments they would have received until maturity. They now need to reinvest that money but likely can’t find the same high interest rate, especially since rates have probably fallen. This is called reinvestment risk.
Types of Call Provisions
Callable bonds can have different types of call provisions that determine when and how the company can redeem the bonds:
American Call
The company can call the bonds anytime after the predetermined call date.
European Call
The company can only call the bonds on specific dates outlined in the bond contract.
Bermuda Call
A combination that allows the company to call on specific dates after the initial call date has passed.
Make-Whole Call
The company can call the bonds at any time, but must pay investors a lump sum that equals the net present value (NPV) of future coupon payments not paid because of the early call. This “make whole” call price is often based on a formula using prevailing market rates.
How Call Price is Determined
The call price, also known as the redemption price, is determined when the bond is first issued. It is outlined in the bond contract or prospectus.
The call price is usually set as a percentage of the bond’s face value, such as 102% or $1020 for a bond with a $1000 face value. The specific percentage often depends on when the bond is called.
Many bonds have call schedules where the call price starts high in the early years and gradually decreases as the bond nears maturity. For example:
- 104% if called in first year
- 103% if called in second year
- 102% if called in third year
- 101% if called in fourth year
- 100% (face value) if called in fifth year or later
This declining schedule incentivizes the company to wait longer to call the bonds. It also gives investors some protection in the early years when a call would be most disruptive to their expected cash flows.
Relationship with Coupon, Yield, and Price
The call price has notable relationships and impacts on the bond’s coupon rate, yield to maturity, and market price.
Coupon Rate
Callable bonds usually pay higher coupon interest rates than non-callable bonds. This compensates investors for the risk that the bonds could be called before maturity. The company pays for the right to call the bonds with higher interest over the bond’s life.
Yield to Maturity
A bond’s yield to maturity (YTM) is the total return anticipated if the bond is held until maturity. However, for callable bonds, investors usually calculate yield to call (YTC) instead, assuming the bond will be called as soon as possible. The YTC is often lower than YTM because the time period is shorter.
Market Price
Callable bonds usually have lower market prices than comparable non-callable bonds. Investors won’t pay as much because of the risk that the bonds could be called before they receive all the interest payments. The actual price depends on the likelihood of the bonds being called based on prevailing rates.
Call Dates and Periods
The call date or call schedule outlines when the company has the right to redeem the bonds at the call price. This is specified in the bond contract.
Many corporate and municipal bonds have a call protection period of 5-10 years. The company cannot call the bonds during this period, giving investors some certainty of their cash flows.
After the call protection ends, the company can call the bonds on specified call dates, often once per year on the coupon payment date. Some bonds are continuously callable, meaning they can be redeemed anytime after the protection period.
Deciding to Call Bonds
The company’s decision to call its bonds essentially comes down to whether it would save money by doing so. Some key factors in the decision:
Interest Rates
If market rates have fallen significantly below the rate on the bonds, the savings from refinancing at lower rates likely justifies paying the call premium. The company compares the NPV of the remaining coupon payments at the original rate versus the new rate plus the call premium.
Financial Health
Even if rates have fallen, the company might not be able to call the bonds if its financial health has worsened. It may no longer qualify to borrow at the new lower rates.
Future Financing Needs
If the company expects to need more financing soon, it might wait to call bonds so it only has to deal with issuing new debt once, rather than calling debt now and then issuing more later. It depends how much the company could save now versus how soon it needs more financing.
Investor Relations
Companies may also consider how calling bonds would affect their relationships with bondholders, especially large institutional investors. Calling bonds might save the company money but leaves investors with reinvestment risk. The company has to balance its priorities.
