Ken Himmler.com

Even if you fully intend to carry a bond through to maturity, the issuer of the bond may have other plans. If interest rates fall heavily and the issuer of your investment bond opts to lower its interest rate expenditures then they may exercise their right to redeem or call in their bonds even before they mature.

If you own a bond that is “callable” then there is some risk of this happening if interest rates drop to attractive levels for the issuer. Should this occur, the issuer will only be required to pay you par value for the bond and this will result in you receiving less than the current market price.

One of the unfortunate aspects of having a bond called is that the market environment that motivates issuers to redeem a bond is the same that often leads to higher bond prices. So not only do you lose the potential of a pre-maturity profit by selling the bond, you’re forced to sell earlier and for less money than you want.

While many callable bonds will have call protection where the bonds can’t be called for a certain period of time, you won’t have any choice but to take par value when and if they do opt to call it in.

It needs to be said that even if interest rates fall, this doesn’t mean your bonds are automatically going to be called in. The issuer will have to see that it can lower its costs by redeeming the bonds at par value and then selling additional bonds with lower yields. Typically, interest rates would have to drop significantly for this to happen.

Because callable bonds carry the risk that you won’t get the return you anticipate, they typically pay a higher rate of interest than non-callable bonds. When considering bond investments, you’ll want to weigh the pros and cons of higher interest/higher risk or lower interest/lower risk depending on your investment goals.

 

Tags: Investment Bonds, Investment for Retirement, Investment Strategies

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