the rate of interest specified in a bond contract as the interest rate to be paid by the company to investors in the bond is known as the market rate.
James
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Chapter 9 Concept Videos (LO9
Study with Quizlet and memorize flashcards terms like Interest on bonds is traditionally paid: a) Once per year b) twice per year c) once per month d) every day, In comparing bonds with notes, bonds are typically issued to a single lender while notes are issued to many lenders. a) True b) False, Bonds that are not supported by specific assets but instead backed only by the "full faith and credit" of the issuing company are known as: a) secured bonds b) serial bonds c) term bonds d) unsecured bonds and more.
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Interest on bonds is traditionally paid:
a) Once per year b) twice per year c) once per month d) every day
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b) twice per year
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In comparing bonds with notes, bonds are typically issued to a single lender while notes are issued to many lenders.
a) True b) False
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b) False
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Terms in this set (22)
Interest on bonds is traditionally paid:
a) Once per year b) twice per year c) once per month d) every day b) twice per year
In comparing bonds with notes, bonds are typically issued to a single lender while notes are issued to many lenders.
a) True b) False b) False
Bonds that are not supported by specific assets but instead backed only by the "full faith and credit" of the issuing company are known as:
a) secured bonds b) serial bonds c) term bonds d) unsecured bonds d) unsecured bonds
Bonds that require payment of the full principal at a single maturity date are known as term bonds.
a) True b) False a) True
Most bonds require payment of the full principal at a single maturity date.
a) True b) False a) True
On January 1, Year 1, Greenbriar Corporation issues callable bonds at face amount that pay 8% interest. The company is most likely to call the bonds if the market interest rate:
a) remains constant at 8%
b) increases to a rate above 8%
c) decreases to a rate below 8%
c) decreases to a rate below 8%
An investor owns a $1,000 convertible bond that can be converted into 10 shares of common stock. The investor should exercise this conversion feature when the company's stock price is:
a) exactly $100 b) more than $100 c) less than $100 b) more than $100
On January 1, Year 1, McGee Corporation issues 5%, 10-year bonds with a face amount of $100,000. Interest is paid semiannually on June 30 and December 31. On issuance date, the market rate of interest is 5%; therefore, the issue price of the bonds is $100,000. The journal entry for the issuance of the bonds will include a:
a) debit to bonds payable for $105,000
b) debit to cash for $105,000
c) credit to bonds payable for $100,000
d) credit to cash for $100,000
c) credit to bonds payable for $100,000
The rate of interest specified in a bond contract as the interest rate to be paid by the company to investors in the bond is known as the market rate.
a) True b) False b) False
When a bond's stated rate of interest is more than the market rate of interest, the bonds will issue:
a) at face amount
b) at more than face amount
c) at less than face amount
b) at more than face amount
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Verified questions
ACCOUNTING
Comparative financial statement data of Panfield Optical Mart follow: Panfield Optical Mart Comparative Income Statements Years Ended December 31, 2012 and 2011
\begin{matrix} & \text{2012} & \text{2011}\\ \text{Net sales } & \text{\$686,000 } & \text{\$592,000 }\\ \text{Cost of goods sold } & \text{380,000 } & \text{281,000 }\\ \text{Gross profit } & \text{306,000 } & \text{311,000 }\\ \text{Operating expenses} & \text{127,000 } & \text{148,000 }\\ \text{Income from operations } & \text{179,000 } & \text{163,000 }\\ \text{Interest expense } & \text{30,000 } & \text{50,000 }\\ \text{Income before income tax } & \text{149,000 } & \text{113,000 }\\ \text{Income tax expense } & \text{38,000 } & \text{45,000 }\\ \text{Net income } & \text{\$111,000} & \text{\$ 68,000}\\ \end{matrix}
Callable Bond Definition
A callable bond is a bond that can be redeemed (called in) by the issuer prior to its maturity.
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BONDS FIXED INCOME Overview
INTRODUCTION TO FIXED INCOME
The Basics Of Bonds
Fixed-Income Security
What Is a Fixed-Rate Bond?
Interest Rates, Inflation, And Bonds
TYPES OF FIXED INCOME
Government Bond
Treasury Bond (T-Bond)
Bonds vs. Notes vs. Bills
Treasury Inflation-Protected Securities (TIPS)
Municipal Bond Corporate Bond Convertible Bond High-Yield Bond Junk Bond Callable Bond
UNDERSTANDING FIXED INCOME
Bond Market vs. Stock Market
Equity Market vs. Fixed-Income Market
Cash vs. Bonds
Money Market vs. Short-Term Bonds
The Secondary Market: "Over the Counter"
Zero-coupon Bond vs. a Regular Bond
FIXED INCOME INVESTING
How Bond Market Pricing Works
Creating a Modern Fixed-Income Portfolio
Whereto Buy Government Bonds
Treasury Bonds and Retirement
RISKS AND CONSIDERATIONS
7 Common Bond-Buying Mistakes
Interest Rate Risk
Pros and Cons of Inflation-Linked Bonds
Callable Bond
By JAMES CHEN Updated April 02, 2022
Reviewed by GORDON SCOTT
Fact checked by TIMOTHY LI
What Is a Callable Bond?
A callable bond, also known as a redeemable bond, is a bond that the issuer may redeem before it reaches the stated maturity date. A callable bond allows the issuing company to pay off their debt early. A business may choose to call their bond if market interest rates move lower, which will allow them to re-borrow at a more beneficial rate. Callable bonds thus compensate investors for that potentiality as they typically offer a more attractive interest rate or coupon rate due to their callable nature.1
KEY TAKEAWAYS
A callable bond is a debt security that can be redeemed early by the issuer before its maturity at the issuer's discretion.
A callable bond allows companies to pay off their debt early and benefit from favorable interest rate drops.
A callable bond benefits the issuer, and so investors of these bonds are compensated with a more attractive interest rate than on otherwise similar non-callable bonds.
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Callable Bond
How a Callable Bond Works
A callable bond is a debt instrument in which the issuer reserves the right to return the investor's principal and stop interest payments before the bond's maturity date. Corporations may issue bonds to fund expansion or to pay off other loans. If they expect market interest rates to fall, they may issue the bond as callable, allowing them to make an early redemption and secure other financings at a lowered rate. The bond's offering will specify the terms of when the company may recall the note.
A callable—redeemable—bond is typically called at a value that is slightly above the par value of the debt. The earlier in a bond's life span that it is called, the higher its call value will be. For example, a bond maturing in 2030 can be called in 2020. It may show a callable price of 102. This price means the investor receives $1,020 for each $1,000 in face value of their investment. The bond may also stipulate that the early call price goes down to 101 after a year.
Types of Callable Bonds
Callable bonds come with many variations. Optional redemption lets an issuer redeem its bonds according to the terms when the bond was issued. However, not all bonds are callable. Treasury bonds and Treasury notes are non-callable, although there are a few exceptions.
Most municipal bonds and some corporate bonds are callable. A municipal bond has call features that may be exercised after a set period such as 10 years.1
Sinking fund redemption requires the issuer to adhere to a set schedule while redeeming a portion or all of its debt. On specified dates, the company will remit a portion of the bond to bondholders. A sinking fund helps the company save money over time and avoid a large lump-sum payment at maturity. A sinking fund has bonds issued whereby some of them are callable for the company to pay off its debt early.1
Extraordinary redemption lets the issuer call its bonds before maturity if specific events occur, such as if the underlying funded project is damaged or destroyed.
Call protection refers to the period when the bond cannot be called. The issuer must clarify whether a bond is callable and the exact terms of the call option, including when the timeframe when the bond can be called.
Callable Bonds and Interest Rates
If market interest rates decline after a corporation floats a bond, the company can issue new debt, receiving a lower interest rate than the original callable bond. The company uses the proceeds from the second, lower-rate issue to pay off the earlier callable bond by exercising the call feature. As a result, the company has refinanced its debt by paying off the higher-yielding callable bonds with the newly-issued debt at a lower interest rate.
Paying down debt early by exercising callable bonds saves a company interest expense and prevents the company from being put in financial difficulties in the long term if economic or financial conditions worsen.
However, the investor might not make out as well as the company when the bond is called. For example, let's say a 6% coupon bond is issued and is due to mature in five years. An investor purchases $10,000 worth and receives coupon payments of 6% x $10,000 or $600 annually. Three years after issuance, the interest rates fall to 4%, and the issuer calls the bond. The bondholder must turn in the bond to get back the principal, and no further interest is paid.
Bond Basics
To better understand bonds and bond funds, start by familiarizing yourself with some basic concepts, starting with what a bond is.
Bond Basics
To better understand bonds and bond funds, let’s start with some basic concepts.
What's a Bond?
A bond is a loan that an investor makes to a corporation, government, federal agency or other organization. Consequently, bonds are sometimes referred to as debt securities. Since bond issuers know you aren't going to lend your hard-earned money without compensation, the issuer of the bond (the borrower) enters into a legal agreement to pay you (the bondholder) interest. The bond issuer also agrees to repay you the original sum loaned at the bond's maturity date, though certain conditions, such as a bond being called, may cause repayment to be made earlier.
The vast majority of bonds have a set maturity date—a specific date when the bond must be paid back at its face value, called par value. Bonds are called fixed-income securities because many pay you interest based on a regular, predetermined interest rate—also called a coupon rate—that is set when the bond is issued. Similarly, the term “bond market” is often used interchangeably with "fixed-income market."
Bond Maturity
A bond's term, or years to maturity, is usually set when it is issued. Bond maturities can range from one day to 100 years, but the majority of bond maturities range from one to 30 years. Bonds are often referred to as being short-, medium- or long-term. Generally, a bond that matures in one to three years is referred to as a short-term bond. Medium- or intermediate-term bonds are generally those that mature in four to 10 years, and long-term bonds are those with maturities greater than 10 years. The borrower fulfills its debt obligation typically when the bond reaches its maturity date, and the final interest payment and the original sum you loaned (the principal) are paid to you.
Callable Bonds
Not all bonds reach maturity, even if you want them to. Callable bonds are common. They allow the issuer to retire a bond before it matures. Call provisions are outlined in the bond's prospectus (or offering statement or circular) and the indenture—both are documents that explain a bond's terms and conditions. While firms are not formally required to document all call provision terms on the customer's confirmation statement, many do so. When you buy municipal securities, firms are required to provide more call information on the customer confirmation than you will see for other types of debt securities.
You usually receive some call protection for a period of the bond's life (for example, the first three years after the bond is issued). This means that the bond cannot be called before a specified date. After that, the bond's issuer can redeem that bond on the predetermined call date, or a bond may be continuously callable, meaning the issuer may redeem the bond at the specified price at any time during the call period. Before you buy a bond, always check to see if the bond has a call provision, and consider how that might impact your investment strategy.
Bond Coupons
A bond's coupon is the annual interest rate paid on the issuer's borrowed money, generally paid out semiannually. The coupon is always tied to a bond's face or par value, and is quoted as a percentage of par. For instance, a bond with a par value of $1,000 and an annual interest rate of 4.5 percent has a coupon rate of 4.5 percent ($45).
Many bond investors rely on a bond's coupon as a source of income, spending the simple interest they receive.
You can also reinvest the interest, letting your interest gain interest. If the interest rate at which you reinvest your coupons is higher or lower, your total return will be more or less. Also be aware that taxes can reduce your total return.
The Power of Compounding
Regardless of the type of investment you select, saving regularly and reinvesting your interest income can turn even modest amounts of money into sizable investments through the remarkable power of compounding. If you save $200 a month and receive a 5 percent annual rate of return, you will have more than $82,000 in 20 years' time.
Accrued Interest
Accrued interest is the interest that adds up (accrues) each day between coupon payments. If you sell a bond before it matures or buy a bond in the secondary market, you most likely will catch the bond between coupon payment dates. If you're selling, you're entitled to the price of the bond, plus the accrued interest that the bond has earned up to the sale date. The buyer compensates you for this portion of the coupon interest, which is generally handled by adding the amount to the contract price of the bond.
Use our Accrued Interest Calculator to figure out a bond's accrued interest.
Bond Prices
Bonds are generally issued in multiples of $1,000, also known as a bond's face or par value. But a bond's price is subject to market forces and often fluctuates above or below par. If you sell a bond before it matures, you may not receive the full principal amount of the bond and will not receive any remaining interest payments. This is because a bond's price is not based on the par value of the bond. Instead, the bond's price is established in the secondary market and fluctuates. As a result, the price may be more or less than the amount of principal and the remaining interest the issuer would be required to pay you if you held the bond to maturity.
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