Why Companies Issue Callable Bonds
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Why Companies Issue Callable Bonds
The primary reason that companies issue callable bonds rather than non-callable bonds is to protect them in the event that interest rates drop. For instance, if a company issues bonds that pay investors the going rate of 7 percent annually in interest, and then the going rate declines to 6 percent, the company may redeem its callable bonds, replacing them with new bonds paying 6 percent annually.
Things To Know
- Companies issue callable bonds to protect them in the event that interest rates drop.
Where it matters most
This is especially crucial for bonds with maturity dates 20 years or more into the future. Without callability, a company might issue bonds with a high interest rate and not be able to change the rate for 20 years. The company could find itself locked into a high rate for many years at a time when new bonds are being issued with much lower interest rates. The company would be at a competitive disadvantage if it continued to finance its debts at the old, higher rate.
The issuer may pay you a premium
Companies are often willing to pay a premium to redeem the bonds before maturity, to avoid the above scenario. Callability enables the company to respond to changing interest rates, refinance high-interest debts, and avoid paying more than the going rates for its long-term debts.