What is a Call Premium?

A call premium is the excess amount over the par value of a bond that the issuer is willing to pay in order to redeem a bond before its maturity date. The call premium is stated as a specific monetary value over a bond’s par value, rather than a percentage amount. Depending on the terms of the bond agreement, the call premium usually declines as the current date approaches the maturity date. This premium is intended to compensate investors for the loss of income if a bond they hold is redeemed, and they have to reinvest the funds elsewhere at a lower interest rate.

A bond issuer usually redeems bonds when the interest rate has dropped to such an extent that it is worth the cost of paying the call premium in order to pay the lower rate on a replacement bond.

Example of a Call Premium

A corporation issues a 10-year bond with a face value of $1,000 and a 5% annual coupon rate. The bond is called after five years, and the terms specify a call premium of 2%. This means that the issuer pays a call price of $1,020. This $20 represents the call premium (2% of $1,000). In this case, a bondholder would receive $1,020 if the bond is called, instead of the $1,000 face value, due to the 2% call premium.