Definition
A call price is the price at which a bond or a preferred stock with a call feature can be redeemed by the issuer before its maturity date. This price often includes a premium above the face value of the security, which compensates investors for the early termination of the investment. This premium is known as the call premium.
The call price is predetermined at the time of issuance and is specified in the bond or preferred stock’s indenture agreement or prospectus. Redemption at the call price allows the issuer to refinance the debt if interest rates decline or if the issuer’s credit standing improves, reducing the cost of capital.
Examples
-
Corporate Bonds: Suppose a corporation issues a bond with a face value of $1,000 and a 5% annual coupon rate. The bond includes a call feature that allows the issuer to redeem the bond after five years at a call price of $1,050. If interest rates decrease after issuance, the issuer might choose to call the bond at the call price, repaying investors $1,050 per bond.
-
Preferred Stock: Consider preferred stock with a $100 par value and a call feature, which allows the issuer to redeem the stock after three years at a call price of $105. If the issuer’s financial position improves, it may opt to redeem the preferred stock at the call price to issue new shares at a lower dividend rate.
Frequently Asked Questions
Q1: Why do issuers include a call feature in bonds or preferred stocks? A1: Issuers include a call feature to retain the flexibility to refinance the securities if interest rates fall or if their credit ratings improve, thereby lowering their borrowing costs.
Q2: How does the call price affect investors? A2: The call price can introduce reinvestment risk for investors, as they may need to reinvest the proceeds from a called bond or preferred stock at a lower interest rate or dividend yield. However, investors are compensated by the call premium.
Q3: What is the difference between a call price and a call premium? A3: The call price is the total amount paid by the issuer to redeem the bond or preferred stock, which includes the par value plus any call premium. The call premium is the extra amount above the par value paid to compensate investors for the early redemption.
Q4: Can the call price change over time? A4: Yes, the call price can be structured to decrease over time, according to a schedule specified in the bond or preferred stock’s indenture or prospectus.
Q5: Are there any drawbacks for issuers in calling a bond or preferred stock? A5: Calling a bond or preferred stock requires the issuer to have sufficient funds to cover the call price. Additionally, issuing new bonds or stocks may incur other costs.
Related Terms
- Call Feature: A provision in a bond or preferred stock that allows the issuer to redeem the security before its maturity date.
- Call Premium: The additional amount over the par value paid by the issuer when redeeming a bond or preferred stock with a call feature.
- Indenture: A legal agreement between the bond issuer and bondholders outlining the terms and conditions of the bond, including any call features.
- Reinvestment Risk: The risk faced by investors that they will need to reinvest the principal from a called bond or preferred stock at a lower rate of return.
Online References
Suggested Books for Further Studies
- “Bond Markets, Analysis and Strategies” by Frank J. Fabozzi
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi and Steven V. Mann
Fundamentals of Call Price: Finance Basics Quiz
Thank you for diving into the intricacies of call prices with our comprehensive definition and quiz. Keep expanding your finance knowledge!
