Callable Securities

A callable security, also commonly referred to as a redeemable security, is a type of security that has a call provision which allows the holder to retire the security early by “calling” or “redeeming” it. With some securities, such redemption may be a required act (also known as mandatory redemption), while other securities leave it to the discretion of the issuer. There are two main types of callable securities – callable preferred stocks and callable bonds. A portion or the entirety of callable securities can be called, however if only a portion is called then the specific parts of the securities that are called will be selected based on lottery, serial number, or another predefined method. When a security is called the investor is given a set value for the security, also known as the “call price”. Coupon bonds and callable preferred stocks usually have a call price that is equal to or higher than the securities par value. Zero-coupon bonds usually have a call price that is equal to or greater than the book value of the security. The following paragraphs review various aspects of callable securities.

Types of Call Provisions for Callable Securities
Call provisions are basically clauses within a callable security’s agreement that gives the security issuer the right to buy back a portion or the entirety of a security before the maturation date. Since there are many reasons to redeem a security, there are also various call provisions, the three most popular of which are – extraordinary redemption, sinking fund redemption, and optional redemption. Extraordinary redemption call provisions are usually applied to bonds, and allow the issuer to redeem a security if specified events (out of the ordinary) happen. For example, a callable security issuer might place an extraordinary redemption call provision on a bond that is being used to finance a property, which states that the bond can be redeemed if destruction to the property occurs. There are also optional extraordinary redemption call provisions, which leave the decision to redeem the security at the discretion of the issuer. A sinking fund redemption call provision makes it mandatory for the issuer to periodically redeem securities. With a sinking fund redemption the issuer may have the right to determine the specific timing of security redemptions. Optional redemption call provisions let the issuer redeem the security at any time, and are explained in further detail below.

Optional Redemption Callable Securities
Although every type of call provision poses some form of investment risk, optional redemption call provisions are perhaps the most risky. In fact, these provisions are usually used by issuers when economic circumstances are foreseen that may make the redemption of the security beneficial for the issuer and non-beneficial for the investor. For example, issuers may use optional redemption call provisions to redeem a security immediately after interest rates drop, allowing the issuer to obtain new financing at lower rates, while forcing the investor to reinvest with lower rates of return. Optional redemption call provisions are also known for having higher call premiums, however some may have a declining call premium which is specified within a ‘call schedule’.

When Can Callable Securities Be Redeemed?
Callable securities can be redeemed at any time after the first call date or issue, and a 30-day notice is typically given by the issuer. However, some callable securities allow ‘continuous call’, which gives the issuer the ability to redeem the security on any business day of the year. Other securities may limit eligible redemption dates to dividend or coupon dates, in which case accrued interest would be paid in addition to the call price. Since the date on which a callable security is redeemed can have a significant impact on investment returns, prospective security holders should thoroughly review contract terms before applying for a callable security.

Comments are closed.