WHAT ARE CHARACTERISTICS OF CALLABLE BONDS?

When a company may redeem a bond after a certain date, this callability is sometimes termed a deferred call. For instance, if you own a bond that may be called after five years, you own a bond with a deferred call provision. You may want to look for bonds that offer call protection—or some measure of time during which the bond may not be called.

If you own a bond that may be called at any time, you own a freely callable bond. In contrast, noncallable bonds cannot be called until maturity, and bonds with this feature offer the investor non-callability.

When you are considering purchasing a bond, you may want to determine the yield-to-call, which is the calculation of the bond's rate of return if it is called as soon as possible—in other words, at the call date. The yield-to-call takes into account the purchase price, redemption price, annual interest payments, and amount of time remaining to the call date.

For example, say that you purchased a $1,000 bond paying 10 percent interest, and that you paid a discounted price of $800 for the bond. It has a call date five years hence, when the company will pay you the bond's par value. To calculate the yield-to-call:

Subtract your price from the par value ($1,000 - $800 = $200)

Divide this figure by the number of years to callability ($200/5 = $40)

Add the annual interest payments ($40 + $100 = $140)

Add the price you paid to the par value, then divide by 2 ($800 + $1,000/2 = $900)

Divide this figure into your answer for step 3 ($140/$900 = 15.5%)

Occasionally, a municipal bond might be redeemed through a catastrophe call, for example, following the destruction of a toll bridge that served as a revenue source to back the bond. In this extraordinary case, investors likely would be paid from funds received from an insurance policy on the bridge.

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