What defines a callable bond?

A callable bond is defined as a bond that can be repurchased or redeemed by the issuing entity before its maturity date at a specified call price. This feature gives the issuer the flexibility to refinance the bond if interest rates decline or if they have excess cash. For example, if market interest rates fall, the issuer might choose to call the bond, repay the bondholders, and then issue new bonds at a lower interest rate, reducing their overall cost of debt.

The call price is typically set at or above the par value of the bond and is specified in the bond's indenture. Investors should understand that callable bonds often come with a higher yield compared to non-callable bonds to compensate for the call risk that investors assume, as they may receive their investment back earlier than expected, especially in a declining interest rate environment.

Bond types that do not align with this definition, such as those that are non-callable, fixed-rate, or convertible, serve different characteristics and investment purposes. Non-callable bonds do not offer the issuer the right to redeem the bond early, fixed-rate bonds maintain the same interest rate throughout their life, and convertible bonds provide the option to convert into equity but do not include the call feature.