What is Call Price?

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The call price of a security is set by the issuer at the time of its issue. It is duly records it in the prospectus or bond indentureBond IndentureBond indenture or bond resolution is a core legal document that serves as a contract binding upon the bond issuer and the bondholder. It comprises all the bond-related information, like details of the issue, its purpose, bond issuer’s obligations and rights of the bondholders.read more. The price ensures better prospects for the issuer but is risky to the investor. As a result, securities with call prices trade at higher prices.

Key Takeaways

  • A call price is the price of callable security that the issuer pays to the investor on redemption before maturity.Callable securities include fixed income instruments like bonds and preferred stocks that can be called back before the end of their life.Call price enables the issuer to refinance its debt at lower interest rates. It benefits issuers more than investors.Issuers offer a call premium to attract investors and compensate them for the higher risk.A call premium is the difference between the call price and the par value of the security.

Call Price Explained       

The call price is usually associated with callable securities like bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more and preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more. This is because they have an in-built call option that permits the issuer to repurchase them before maturity. Their redemption is at a pre-established price and time, which is disclosed at the time of issue of such securities. This pre-set price is referred to as the call price.

The details related to the issue of callable securities to the investors are enclosed in an indenture (for bonds) and prospectus (for preferred stock). An indentureIndentureIndenture is a legal agreement between two or more parties to meet their respective obligations. It is a common term used in the bond market to provide the lender and borrower with the necessary comfort in the transaction in the event of one defaulting party.read more specifies the call provision, which is the clause for early redemption. It contains the terms and conditions of redemption and multiple dates for a call back of security throughout its lifetime.  

The call provision sets the price that the issuing company will pay to the investors on the redemption of the securities. The company normally fixes the CP at a higher value than the actual face value of the callable security. However, as the callable securities near their maturity date, their price reduces. 

The difference between the actual value and the call price is called call premium. The issuing company offers a call premium to the investors to compensate them for the risk arising out of early redemption. They also offer higher interest rates on callable bondsCallable BondsA callable bond is a fixed-rate bond in which the issuing company has the right to repay the face value of the security at a pre-agreed-upon value prior to the bond’s maturity. This right is exercised when the market interest rate falls.read more and more dividends on callable preferred stocksCallable Preferred StocksCallable preferred stock is stock in which the issuer has the right to repurchase such issued stock after a pre-decided date at a specific price mentioned in the prospectus when the stock is issued. Such a price cannot be changed at any point in the future or at the time of redemption.read more to make them attractive to investors.

Benefits and Risks of Call Provision

An issuer calls a bond before maturity to reduce its cost of borrowing. It will do so when interest rates are falling. In such a scenario, it may call back the bonds at a CP and reissue them at a lower rate as it will reduce its funding cost. Similarly, a company may also buyback its preferred stock to avoid paying dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more and modify its capital structureCapital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities.read more.

Investors usually invest in callable bonds to enjoy a higher interest rate than non-callable securities. Though they receive a call premium in case of a buyback, they have greater exposure to riskExposure To RiskRisk Exposure refers to predicting possible future loss incurred due to a particular business activity or event. You can calculate it by, Risk Exposure = Event Occurrence Probability x Potential Lossread more. They have to bear the loss of future interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more and the risk of reinvestmentRisk Of ReinvestmentReinvestment risk refers to the possibility of failing to induce the profits earned or cash flows into the same scheme, financial product or investment. It even states the uncertainty of not getting the similar returns when such funds are invested in a new investment opportunity.read more at lower interest rates.

Examples

Let us understand the concept of the CP better using the examples given below.

Example #1

Let us consider a multinational firm XYZ Inc. issuing callable bonds to investors with a maturity period of 10 years at a 10% rate of interest. The face value of a bond is $200. The bond indenture details the call provision, including call prices, call dates, and the terms and conditions of the redemption.

As per the terms contained in the indenture, the firm XYZ can call or redeem its preferred stocks or bonds in the third, sixth, and ninth years respectively. Since XYZ issued the bonds in 2012, it could buy them back in 2015, 2018, and 2021.

The CP of the bond for these years is $250 (2015), $230 (2018), and $220 (2021). Therefore, if XYZ exercises its right to repurchase its shares in the year 2018, then it must buyback the shares at the CP of $230.

In this case, XYZ has to offer $30 as a call premium.

Call Premium = Call Price – Face value of the Bond

                        = $230 – $200 = $30

The bondholdersBondholdersA bondholder is an investor who buys or holds a government or corporate bond.read more receive $30 as a call premium but have to forgo their future interest income and find a comparable investment offering similar interest. On the other hand, the bond issuer can refinance its debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more at lower rates.

Example #2

In this example, let’s focus on the financial gains of the bond issuer. Suppose a firm, A2Z Inc., offers a callable bond for ten years at a 10% interest rate in 2022. The face value of the bond is $100. As per the bond indenture, callable intervals are in the fifth (2027) and the seventh (2029) year. The CP is $120 for 2027 and $110 for 2029.

Suppose the interest rate remains 10% in 2027. In this case, A2Z will not benefit from exercising the call provision. So, it will refrain from buying back the bonds.

However, if the interest rate for the bond decreases to 8% in 2029, then A2Z can utilize the CP to buyback the bonds from the investor at $110. Rather than paying the bondholder at 10% till maturity, A2Z may reissue new bonds at 8% and redeem the callable bonds at a call premium of $10. Thus, it will be able to refinance its debt at 8%, saving 2% in interest payments.

Importance of Call Price

CP is quite important to both the investor as well as the issuer. First of all, the callable nature of the securities puts the return on maturity at a question mark for the investor. Secondly, the investor has to weigh the benefit of a high call price against the risk of losing interest/dividend income in the future.

Also, the investor has to put up with the risk of reinvesting at lower interest rates in case of callbacks. Lastly, the investor has no control over the ownership of the security as the firm can recall it at callable intervals.

For the issuer, the call price is a tool to gain investors’ confidence and achieve funding for the business without any risk. When interest rates are falling, the bond issuer may redeem the bonds at call price and reissue them at lower rates, thereby minimizing its debt cost.      

This has been a Guide to Call Price & its Meaning. Here we discuss the concept of call price of bonds & preferred stocks along with its importance & examples. You may also have a look at the following articles to learn more –

The callable securities issuing firm uses the call price to redeem them before maturity when it feels that the interest rates are falling. With lower interest rates prevailing in the market, the issuer can buyback the securities and obtain funds at lower rates by reissuing them. Thus, it can decrease the cost of borrowing.

Most of the call price advantages are directed toward the callable security issuing firm. The issuer can: • Get huge savings in interest payment to investors upon early redemption.• Finance its obligations at lower interest rates.• Modify its capital structure for its benefit.

The callable security investor may fail to get his expected interest on the bond as it may redeem before maturity. So, an investor should invest in non-callable bonds to save his investment and earn extra income.

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