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Callable Bond


bond that contains a provision giving the issuer the right to buy back (call) the bond at a predetermined price (call price) on a specified date or after a given period of time, prior to maturity date. The call price is usually above the par value. The issuer can take advantage of the call provision in the event of a decline in interest rates, which increases market prices beyond the call price. This provision places a cap on the bond price, and as such protects issuers from unfavorable market movements.

The value of a callable bond is equal to the value of a noncallable bond minus the value of the call feature. Pricing a callable bond starts with calculating the value of the underlying debt as normal debt using the discounted cash flow method. In order to value the call feature, it is necessary to measure the benefit of holding or exercising the option, using an option pricing model, based on the value of the debt at different option valuation dates over the bond’s time to maturity.

A callable bond is also known as a redeemable bond.



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