Definition of Callable Bond

What is a "callable bond"? What is the definition of a "callable bond"? What does the term "callable bond" mean?

A callable bond, also known as a redeemable bond, is a bond that can be redeemed by the issuer prior to the maturity date.

In the case of a callable bond, investors will normally receive a higher coupon (interest rate) compared to a non-callable bond. In addition, there is normally a premium paid to investors when bonds are called prior to their maturity dates.

So why would a corporation or government want to call bonds early?

Simple - if interest rates fall, then corporations or governments can "refinance" and issue new bonds with a lower interest rate. So, older bonds with higher interest rates will be called, while new bonds with lower interest rates will be offered in their place.

Whenever interest rates fall, you can expect that many bond issuers with callable bonds will take advantage and refinance their bonds at a lower rate.

For instance, when interest rates started to fall substantially in the United States in the '90s, many bond issuers called their old bond issues to rewrite new bonds at a lower rate. This is only smart business - there is no point in paying higher interest rates than necessary, especially when you have paid a premium to be able to issue callable bonds.

Note: not all bonds are callable - many issues are non-callable, meaning that they can not be called back in by the issuer. These bonds will have lower coupon rates due to the fact that they can't be called back in.

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