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Take Cover (from Calls) Non-callable bonds are called bullet securities—"bullets" for short. Why the funny name? Because they take aim at the maturity date—and once fired (issued), they don't stop (get called) until that maturity date is hit. |
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As discussed earlier, bonds with a call provision may be redeemed or called by the issuer, requiring you to redeem the bonds at their face value well before their maturity dates. Similar to when a homeowner seeks to refinance a mortgage at a lower rate to save money when loan rates decline, a bond issuer often calls a bond when interest rates drop, allowing the issuer to sell new bonds paying lower interest rates—thus saving the issuer money. For this reason, a bond is often called following interest rate declines. The bond's principal is repaid early, but the investor is left unable to find a similar bond with as attractive a yield. This is known as call risk.
With a callable bond, you might not receive the bond's original coupon rate for the entire term of the bond, and it might be difficult or impossible to find an equivalent investment paying rates as high as the original rate. This is known as reinvestment risk. Additionally, once the call date has been reached, the stream of a callable bond's interest payments is uncertain, and any appreciation in the market value of the bond may not rise above the call price.
| Smart Move To protect against unwelcome calls, always study the call provisions and any published call schedules thoroughly before buying a bond. Ask your broker for complete call information. Remember that bonds are generally called during periods of declining interest rates, so it pays to be particularly mindful of a bond's potential to be called during such times. |
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