Callable Bonds

What is a Callable bond?

A callable bond is a bond with a fixed rate where the issuing company has the right to repay the face value of the security at a pre-agreed value prior to the maturity of the bond. The issuer of a bond is having no obligation to buy back the security, he only has the right option to call the bond before the issue.

The above is an example of Senior Secured Callable Bond due 22 March 2018 have been issued and registered with Verdipapirsentralen (VPS),

Callable bond = Straight/ Non callable bond + option

Please note that some of the callable bonds become non-callable after a specific period of time after they issued. This time is called ‘protection period’


  • The issuer company has a right but not an obligation to redeem the bond before maturity.
  • The call price is usually more than the issue price (Par price).
  • The underlying security has a variable life
  • The call option may have multiple exercise rates.
  • Generally, these bonds have a higher interest rate (Coupon rate).
  • The premium for the option sold by the investor is incorporated in the bond by way of the higher interest rate.
  • The call option generally has multiple exercise rates.


Company “A” has issued a callable bond on 1st October 2016 with an interest of 10% p.a maturing in 30th September 2021. The amount of issue is 100 Crores. The bond is callable subject to 30 days’ notice and the call provision is as follows.

Call DateCall price
1 year (30th September 2017)105% of Face value
2 years (30th September 2018)104% of Face value
3 years (30th September 2019)103% of Face value
4 years (30th September 2020)102% of Face value

In the above example, the company is having an option to call the bonds issued to investors before the maturity date of 30th September 2021.

If you see, the initial call premium is higher at 5% of the face value of a bond and it gradually reduced to 2% with respect to time.

Purpose of issuing a callable bond

In case interest rates are falling, then the callable bonds issuing company can call the bond and repay the debt by exercising call option and then they can refinance the debt at a lower interest rate. In this case, the company can save interest costs.

For example: On 1st November 2016 if a company issues a 10% callable bond with a maturity of 5 years. If the company exercises call option before maturity, then it has to pay 106% of face value.

In this case, if as on 31st November 2018 the interest rates fell to 8%, the company may call the bonds and repay them and take debt at 8%, thereby saving 2%.

Should we buy such bonds?

  • Before investing one has to balance return and risk. And callable bonds are too complex to deal with.
  • Generally, when interest rates fall, normal bond prices go up. But, in the case of callable bonds, then bond prices may fall. This kind of phenomenon is called “compression of price”
  • These bonds generally have higher interest rates to compensate for the risk of being called early due to falling interest rates and
  • They are generally called at a premium (i.e price higher than the par value) This is due to additional risk investor takes.
  • For Example, Bond investors may get back Rs 107 rather than Rs 100 if the bond is called. This Rs  7 additional is given due to risk that investor takes in case company recalls bond early in falling interest rates scenario
  • So, one has to ensure that the callable bond offers a sufficient amount of reward (Maybe in the form of higher interest rate than a market or maybe higher repayment premium) to cover the additional risks that the bond is offering.

Structuring of Call Options

Before issuing the bond, one of the important and complicating factors in deciding the following two factors…

  1. The timing of the call. I.e, when to, call
  2. Determination of the price of the bond that is being called. How much to pay off bond is called before the due date

Timing of Call

The date on which the callable bond may be first called is “first call date”. Bonds may be designed to continuously call over a specified period or may be called on a milestone date. A “deferred call” is where bond may not be called during the first several years of issuance.

There are different types in terms of timing

  • European option: Only Single call date before the maturity of the bond
  • Bermudan option: There are multiple call dates before the maturity of the bond
  • American Option: All dates before maturity are call dates.

Pricing of Call

The pricing of the bond generally depends on the provisions of the bond structure. The following are the different kinds of pricing

  • Fixed regardless of the call date
  • Price fixed based on a predetermined schedule

Learn more about Options –  What are Options in Finance and Options Trading Strategy

The decision of calling a Bond

The issuer decision to call is based on many factors like

Valuing the Callable bonds

Generally, the yield is the measure for calculating the worth of a bond in terms of anticipated or projected return. There are various measures in calculating the yield.

Yield to maturity:

YTM is the aggregate total returnTotal ReturnThe term “Total Return” refers to the sum of the difference between the opening and closing value of all the assets over a particular period of time and the returns thereon. To put it simply, the changes in opening and closing values of assets plus the number of returns earned thereof is the Total Return of the entity over a period of more a bond gives if it is held till maturity. It is always expressed as an annual rate.

YTM is also called a book yield or redemption yield.

A simple method to calculate YTM is as follows

YTM formula = [(Coupon) + {(Maturity Value – Price paid for bond)/(no of years)}] / {(maturity value + price paid for bond)/2}

Let us take an example to understand this a better way

Face value/maturity value of a bond is Rs 1000, No of years of maturity is 10 years, the interest rate is 10%. The price paid to purchase the bond is Rs 920

Numerator = 100+(1000-920)/10

Denominator = (1000+920)/2 = 960

YTM =108/960= 11.25%

This YTM measure is more suitable for analyzing the non-callable bonds as it does not include the impact of call features.  So the two additional measures that may provide a more accurate version of bonds are Yield to Call and Yield to worst.

Yield to call

Yield to callYield To CallYield to call is the return on investment for a fixed income holder if the underlying security, such as a callable bond is held until the pre-determined call date rather than the maturity more is the yield that the bond gives is you were to buy the callable bond and hold the security till the call exercise date. A calculation is based on the interest rate, time till call date, the market price of the bond and call price. Yield to call is generally calculated by assuming that the bond is calculated at the earliest possible date.

For example, Mr. A owns a bond of GOOGLE company with a face value of Rs. 1000 at a 5% zero-coupon rate. The bond matures in 3 years. This bond is callable in 2 years at 105% of par.

In this case, to calculate the yield of the bond, Mr.A needs to assume that bond matures in 2 years instead of 3 years. Call price should be considered at Rs 1050(Rs1000*105%) as principal at maturity.

Let us assume price paid to buy the bond in the secondary market is Rs 980, then yield to call will be as follows

{Coupon + (call value- price)/time of bond} / {(Face value + price)/2}

Coupon payment is Rs 50 (i.e Rs 1000*5%)

Call value if Rs 1050

Price paid to acquire bond value is Rs 920

Time of bond is 2 years (Assuming call happens in 2 years)

Market price is Rs 980

YTC =  [50+(1050-920)/2]      (1000+920)/2

= 50+65/960   =12%                       

Yield to worst

Yield to WorstYield To WorstThe yield to worst (YTW) is the minimum yield that can be received on a bond, assuming the issuer doesn’t default on any of its payments. YTW makes sense for bonds where the issuer exercises its options like calls or prepayments. YTW = risk free rate + credit risk premium read more is the lowest yield an investor expects while investing in a callable bond. Generally callable bonds are good for the issuer and bad for the bondholder because when interest rates fall, the issuer chooses to call the bonds and refinance its debt at a lower rate leaving the investor to find the new place to invest.

Soo, in this case, Yield to worst, is very important who wants to know what is the minimum they can get from their bond instruments.

Please note that ‘Yield to worst’ is always lower than ‘Yield to maturity’

For example, A bond is maturing in 10 years and Yield to maturity(ytm) is 4 %. The bond has a call provision where the issuer can call bonds in five years. The yield calculated assuming that the bond is maturing on call date (YTC) is 3.2%. In this case, Yield to worst is 3.2%

Also, check out Bond PricingBond PricingThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash more

Now let us look at the Opposite of Callable Bond – Puttable Bond

Puttable bonds

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