What is a Call Price?

A call price is the price at which the holder of a bond can be forced by the issuer to sell back the bond to the issuer. A call occurs prior to the maturity date of the bond, usually because the issuer can refinance the debt at a lower interest rate. The call price is typically the face value of the bond, plus an additional percentage. The amount of the call price and the dates during which it can be enacted are specified in the indenture agreement associated with the bond.

Disadvantages of a Call Price

While callable bonds can provide flexibility for issuers, they introduce disadvantages for investors. Here are the key disadvantages:

Reinvestment risk. When a bond is called, investors receive the call price (usually at a premium to par value) but may have difficulty reinvesting the proceeds at a similar or better interest rate, especially in a declining interest rate environment. This can reduce overall returns.
Limited price appreciation. Callable bonds typically have a ceiling on their price, as the potential for capital appreciation is capped by the call price. If interest rates fall, the issuer is likely to call the bond, preventing the bond price from rising significantly.
Uncertainty of cash flows. The possibility of an early redemption introduces uncertainty for investors, as they cannot rely on receiving interest payments for the full term of the bond.
Higher yields may not compensate for risks. Callable bonds generally offer higher yields to compensate for the call risk, but this added yield might not fully offset the potential disadvantages, especially if the bond is called in a low-interest-rate environment.
Complex valuation. Callable bonds are more complex to value than non-callable bonds because their price depends on factors like interest rates, the bond's call schedule, and the likelihood of the issuer exercising the call option. This complexity can make them less appealing to some investors.
Reduced marketability. Callable bonds may be less attractive to certain investors due to the risks mentioned above, potentially reducing their liquidity and marketability in the secondary market.

By considering these disadvantages, investors can better evaluate whether callable bonds align with their investment objectives and risk tolerance.

There are also concerns from the perspective of the issuer. The issuer of a bond containing a call price will have to accept a lower price for them, in order to compensate investors for the risk of losing income if the bonds are called at some point in the future. Thus, the issuer will need to weigh the benefit of having a call price feature against the increased effective interest rate that investors will demand in exchange.