Callable Security

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Callable Security</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="98%" align="left" valign="top"><p class="word_list"> <a href="#call premium">call premium</a><p class="word_list"> <a href="#call price">call price</a><p class="word_list"> <a href="#call protection">call protection</a><p class="word_list"> <a href="#call provision">call provision</a><p class="word_list"> <a href="#call schedule">call schedule</a><p class="word_list"> <a href="#callable security">callable security</a><p class="word_list"> <a href="#continuous call">continuous call</a><p class="word_list"> <a href="#extraordinary mandatory redemption">extraordinary mandatory redemption</a></p> <p class="word_list"><a href="#extraordinary optional redemption"> extraordinary optional redemption</a> </p> <p class="word_list"><a href="#Extraordinary redemption"> extraordinary redemption</a></p> <p class="word_list"> <a href="#first call date">first call date</a><p class="word_list"> <a href="#mandatory redemption">mandatory redemption</a><p class="word_list"> <a href="#Optional redemption">optional redemption</a><p class="word_list"> <a href="#redeemable security">redeemable security</a><p class="word_list"> <a href="#Sinking fund redemption">sinking fund redemption</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="left" id="table5"> <tr> <td width="300" height="14"><font size="2"> </font><font size="4"> </font></td> <td width="9" height="14"></td> </tr> <tr> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p style="margin-bottom: 24; margin-top:16" class="body">A <b> <a name="callable security">callable security</a></b> (or <b> <a name="redeemable security">redeemable security</a></b>) is a <a href="../articles/security.htm">security</a> with a <b> <a name="call provision">call provision</a></b>. This provides for the early retirement ("call" or "redemption") of the security.  Redemption may be required (<b><a name="mandatory redemption">mandatory redemption</a></b>) or it may be at the issuer's option. The two common forms of callable securities are <a href="../articles/preferred_stock.htm">callable preferred stock</a> and <a href="../articles/callable_bond.htm">callable bonds</a>. </p> <p style="margin-bottom: 24; margin-top:16" class="body">All or part of an issuance may be called. If only part is called, the specific securities to be retired may be selected by serial number, lottery or some other mechanism. </p> <p style="margin-bottom: 24; margin-top:16" class="body">Investors whose securities are called are paid a specified value, called the <b><a name="call price">call price</a></b>. For callable <a href="../articles/preferred_stock.htm">preferred stock</a> or <a href="../articles/coupon_bond.htm">coupon bonds</a>, the call price may be the security's <a href="../articles/par_value.htm">par value</a>, or it may be a price somewhat higher than the par value. For <a href="../articles/zero_coupon_bond.htm">zero-coupon bonds</a>, the call price may be equal to or greater than the security's <a href="../articles/valuation.htm">book value</a>. The difference between a security's call price and par value (or book value) is the <b> <a name="call premium">call premium</a></b>. </p> <p style="margin-bottom: 24; margin-top:16" class="body">There are different reasons why an issuer might call securities, so securities may be issued with multiple call provisions. Three types of call provisions are commonly encountered:</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table6"> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10"><b><a name="Optional redemption">Optional redemption</a></b> allows the issuer to call the security for any reason. </p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10"><b><a name="Extraordinary redemption">Extraordinary redemption</a></b> primarily applies to bonds. It provides for redemption if certain specified events occur. One such event might be the destruction of facilities a bond was issued to finance. In such a case, funds for the redemption would come from an insurance policy covering the facilities. Another event might be a determination that interest payable on a <a href="../articles/municipal_securities.htm">municipal bond</a> was taxable. If a specified event occurs, redemption may be mandatory or at the issuer's option, so there is <b> <a name="extraordinary mandatory redemption">extraordinary mandatory redemption</a></b> and <b><a name="extraordinary optional redemption"> extraordinary optional redemption</a></b>.</p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10"><b><a name="Sinking fund redemption">Sinking fund redemption</a></b> requires the issuer to periodically redeem some securities to satisfy a <a href="../articles/sinking_fund.htm">sinking fund</a> provision. The issuer may retain some flexibility over the timing of redemptions.</p> <p class="body">While all of these pose <a href="../articles/risk.htm">risk</a> for investors, it is optional redemption provisions that are of most concern. Issuers tend to exercise such provisions for economic purposes—and market conditions that make a redemption economically advantageous for an issuer tend to make it economically disadvantageous for investors. The most common scenario is of an issuer calling a bond after interest rates have fallen. The redemption benefits the issuer, who is able to secure new financing at lower interest rates. It hurts investors who are forced to reinvest at lower interest rates.</p> <p class="body">Securities with optional redemption provisions are issued with higher <a href="../articles/yield.htm">yields</a> than comparable securities that lack such provisions. The extra yield is like an <a href="../articles/time_value_and_intrinsic_value.htm">option premium</a> compensating investors for the <a href="../articles/short_sale.htm">short</a> <a href="../articles/option.htm">call option</a> the redemption provision represents. Optional redemption provisions may also have high call premiums. These make it desirable for the issuer to call the security in only the most favorable economic conditions—and mitigates the investors' loss in the event that a redemption actually occurs. </p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table7"> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p class="body">Some optional redemption provisions have a declining call premium specified as a <b><a name="call schedule">call schedule</a></b>. For example, a <a href="../articles/currency_codes.htm">USD</a> 1,000 par value bond might have a USD 100 call premium for its first five years, a USD 50 call premium for the next five years, and be callable at par after that. Another safeguard for investors is <a name="call protection"> <b>call protection</b></a>, which limits optional redemption during the first few years of a security's life. Typically, this takes the form of a prohibition against optional redemption during that period. The <b> <a name="first call date">first call date</a></b> is the earliest date on which the security is fully callable. </p> <p class="body">A security can generally be called any time after its issuance or first call date, usually with a month's notice or so. As a practical matter, this may be limited to <a href="../articles/bond_accrued_interest.htm">coupon dates</a> or dividend dates, but some callable securities allow <b><a name="continuous call">continuous call</a></b>, which is redemption on any business day. If a security is called between coupon or dividend dates, <a href="../articles/bond_accrued_interest.htm">accrued interest</a> is paid along with the call price.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table9"> <tr> <td width="100%"> <p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/coupon_bond.htm">bond</a> Securitized debt.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/callable_bond.htm">callable bond</a> </strong>A bond that can be retired ("called" or redeemed") early.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/compounding.htm">compounding</a> Simple, compound and continuously compound interest.</p> <p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/corporate_bond.htm">corporate bond</a> A bond issued by a corporation.</strong></p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/duration_and_convexity.htm">duration and convexity</a> Risk metrics employed in fixed income markets.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/fixed_income_term_structure.htm">fixed income term structures</a> Overview article.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/interest_rate_spreads.htm">interest rate spreads</a> Discusses credit spreads, liquidity spreads, optionality spreads, etc. in the fixed income markets.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/option_adjusted_spread.htm">option-adjusted spread</a> Yield spread not attributable to embedded options.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/security.htm">security</a> A financial instrument such as a stock or bond.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/sinking_fund.htm">sinking fund</a> A provision that requires an issuer of bonds or preferred stock to retire some of the issue each year.</strong></p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/swaption.htm">swaption</a> An option on a swap.</strong></p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/yield.htm">yield</a> Any of several metrics of the income or return to be earned from an investment.</strong></td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_2.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%">  <p class="ad_legend" style="margin-left: 0; 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