What is a Call Price?
The call price (also known as “redemption price”) is the price at which the issuer of a callable security has the right to buy back that security from an investor or creditor. Call prices are commonly found in callable bonds or callable preferred stock. The call price is set at the time the security is issued and is known by reading the issue’s prospectus.
The call price is the pre-determined price at which the issuer of a callable security is able to redeem them from investors.
Because callable securities generate additional risk for investors, bonds or shares with call prices will trade at a higher price than otherwise, known as the call premium.
Significance of Call Price
For bonds, the call price and the timeframe that it can be triggered are typically set out in the bond indenture agreement. It allows the issuer of the bond to demand the buyer to sell the bond back, usually at its face value, along with the agreed upon percentage due. The premium may be fixed at an interest rate of one year. Based on the structure of the terms, the premium may decrease as the bond matures due to the amortization of the premium.
Some non-callable bonds may become callable after an initial period of time. When a company calls back a bond, it usually makes considerable economic gains in potential interest savings. The gains are made at the cost of a bondholder, who foregoes the lost interest income as the lender is not required to make interest payments after the bond is redeemed.
A business can also exert its right to call preferred shares if it decides to pay out the preferred shareholders and to discontinue dividend payments. It may be done to alter the capital structure of the company or to reduce preferred share dividend payments.
Investors must understand that the presence of an embedded call option in the bond influences the liquidity of the bond. A non-callable bond is worth more than a callable bond to the investors since the bond’s owner has the right to redeem a callable bond and deny the bondholder of the extra interest payments to which he/she would have been eligible if the bond had been retained to maturity.
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.
For example, let’s say the TSJ Sports Conglomerate issues 100,000 preferred shares with a face value of $100 with a call provision built in at $110. This means that if TSJ were to exercise its right to call the stock, the call price would be $110.