Callable Bond

Issuers include call features so they can refinance if interest rates fall. If rates drop, the issuer can repay the existing bonds and issue new ones at a lower rate, reducing its interest costs.

For investors, this is a disadvantage. Their bonds are likely to be called exactly when rates have fallen, so they must reinvest their money at lower rates. Callable bonds also gain less in price when rates fall, because the market expects them to be called.

For example, a company issues ten-year bonds paying 6%, callable after five years at 101. If rates fall to 4% after five years, the company may call the bonds, paying investors 101 per 100 of face value, and refinance at the lower rate.

To compensate for this risk, callable bonds usually pay higher interest than comparable non-callable bonds. Investors often look at yield to call and yield to worst, the lowest yield possible if the bond is called at the worst time for them. Many corporate, municipal and some government bonds are callable.