What is a Call Price?
A call price refers to the price that a preferred stock or bond issuer would pay to buyers if they chose to redeem the callable security before the maturity date. The price is set during the issuance of the security and mentioned in the prospectus of the issue.
Call price terms are found in callable preferred stocks or callable bonds. The issuer of the preferred stock or bond has the option and right to buy that bond or preferred stock back from the creditor or investor at the call price prior to maturity.
- Call price refers to the price that a preferred stock or bond issuer would pay to buyers if they chose to redeem the callable security before the maturity date.
- The call price terms and the timeframe that it can be triggered are established in the bond indenture agreement or the preferred share prospectus.
- Callable securities allow the issuers to buy back the issued security at a specified price – known as the call price – and are executed when there is a favorable change in the market price or interest rate.
Significance of Call Price
For bonds, the call price and the timeframe that it can be triggered are typically set out in the bond indenture agreement. It allows the issuer of the bond to demand the buyer to sell the bond back, usually at its face value, along with the agreed upon percentage due. The premium may be fixed at an interest rate of one year. Based on the structure of the terms, the premium may decrease as the bond matures due to the amortization of the premium.
Some non-callable bonds may become callable after an initial period of time. When a company calls back a bond, it usually makes considerable economic gains in potential interest savings. The gains are made at the cost of a bondholder, who foregoes the lost interest income as the lender is not required to make interest payments after the bond is redeemed.
A business can also exert its right to call preferred shares if it decides to pay out the preferred shareholders and to discontinue dividend payments. It may be done to alter the capital structure of the company or to reduce preferred share dividend payments.
Investors must understand that the presence of an embedded call option in the bond influences the liquidity of the bond. A non-callable bond is worth more than a callable bond to the investors since the bond’s owner has the right to redeem a callable bond and deny the bondholder of the extra interest payments to which he/she would have been eligible if the bond had been retained to maturity.
Call Price and Call Premium
Callable securities are normally present in fixed-income markets. They allow the issuers to buy back the issued security at a specified price in the event of a change in the market price or interest rate. The price is denoted as the call price. Thus, callable securities enable issuers to protect themselves from increasing interest rates.
For example, if a business issues a bond that pays a fixed coupon at 4% and the interest rate is also 4%, it will utilize the call option to repay the bond if the interest rate decreases to, say, 2.5%, as it then can refinance the debt and save 1.5% in interest payments.
Since the call option favors the lender and not buyers, the bonds sell at high premiums to reimburse the bondholders for:
- Reinvestment risk
- Depriving them of potential interest income
Therefore, a call premium must be paid by the issuers to compensate bondholders. The call premium shall be a value over and above the security’s face value. Said another way, the difference between the bond’s call price and the specified par value is the call premium.
Non-callable securities or bonds that are redeemed early will incur steep penalties.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: