What is a callable bond?

Answer 1

A bond that can be bought back by the issuer before the call date.

Answer 2

A callable bond is one that can be redeemed by the issuer before the bond's term expires. Bonds are issued in $1,000 denominations and their prices are quoted in percentages of $1,000. For example, a bond selling at 98.5 has a market price of $950. It is selling at a discount. A bond quoted at 101.75 is selling for $1017.50. It is selling at a premium.

The call price of a bond is usually somewhat higher than the $1,000 face value, so that the holder of the bond is compensated for the problem of having to find another investment if the bond is called. A 10 year bond may be issued at face value and may be callable at 103 in the seventh year, 102 in the eighth year, and 101 in the ninth year. If it is in the interest of the issuer to redeem the bond early, the issuer has to pay the call premium to the bond holder. In the above example, the bond cannot be redeemed early prior to the seventh year of its existence.

It may be that interest rates have risen since the bond was issued, in which case the bond may be selling at a discount in the market. In that case, instead of calling the bond and paying the call premium, the issuer can redeem the bond at a lower cost by buying it in the market at the prevailing discount.