Essay Example on Callable Bonds: Borrow, Repay Later at a Beneficial Rate

Introduction

Also termed as a redeemable bond, a callable bond is a bond that the organization or the individual gives it may decide to redeem before it attains maturity. It is a bond that allows an organization to pay its debts earlier than the stipulated time. An enterprise may choose to go for the bond and pay off the debt in a case where the market interest rates decrease hence allowing the business to borrow more and repay later at a beneficial rate. The investors are callable. Therefore, they make use of the callable bond to exploit the nature of the businesses and give the organization interest rates that will be more appealing and beneficial to them. In the long run, the investors are the ones who benefit from the investment opportunities that the organization engages in (Foerster, 2015). Therefore, a callable bond is a form of security that is issued and can be redeemed early to allow the organizations to pay their debts sooner than expected so that they can borrow considering more profitable ways in the market.

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How a callable bond works

According to the information given by the scholars, a callable bond allow the issuer to have the right to return the principal borrowed debt to the investors and cease the payment of the interest before the bond matures. Organizations that want to expand their borrowing will borrow from other organizations and pay off other organizations. Therefore, in the process of borrowing, they issue a callable bond. This is applicable when they expect the market rates and the borrowing rats to go down. This will give them an edge that will see them secure the financing they require at lower rates. In the making of the bond, the terms under which the bond will be applicable and can be recalled are recorded down and documented in the bond’s offering.

The guidelines that conspire in the calling of the callable bond have determined that when the bond is called earlier in the period given for maturity, then the bond will be of higher value when compared to when the bond is drawn at a later stage in the maturity period(Becker, Campello, Thell & Yan, 2018). For instance, if a bond is supposed to mature in 2030, it can be called for redemption in 2020. If its price is clocked at 102 as the callable price, it is evident that the investors will receive 1020 for every single 1000 as the interest for their investment. However, an early call will see the price of the investors going down to 101 annually.

Conclusion

To sum up, callable bonds are often used in the expansion of organizations. When the market rates decline, and the company has already issued a corporate bond, they can give out a new debt that goes hand in hand with the decreased interest rates lower than the callable bond. Therefore, the callable bonds are a form in which the organizations that issue the bonds can redeem themselves and obtain debt at lower interests. However, most of the organizations utilize this aspect in the process of expansion and debt payment. Hence, they ask for debts from other organizations to pay for other organizations.

On the other hand, the organization that is receiving the debt is the organization that can come up with a callable bond. However, contained in the callable bond are the terms under which the bond is valid to be redeemed. On the other hand, when an organization pays its debt early through the callable bond, the additional expenses are prevented hence helping the organization avoid financial difficulties.

References

Becker, B., Campello, M., Thell, V., & Yan, D. (2018). Debt Overhang and the Life Cycle of Callable Bonds. Swedish House of Finance Research Paper, (18-16).

Foerster, S. (2015). Financial management: Concepts and applications. Pearson Higher Ed.