Them silly Americans...callin' their bonds any time they want. That's what an American callable bond is: the company or government issuing the bond can call it at any time prior to its coming due.
Why would an issuer call a bond? Not because they're lonely on a Friday night ("hey bond, u up?"), but because interest rates have gone down or their rating at Moody's went up. The issuer can call the bonds and issue new ones at a lower interest rate, saving them cash.
Why would an investor want to buy these bonds if they can be called at any time? They usually carry higher coupons than non-callable bonds.
Example: Let's say that a pretzel company issues a callable bond paying 9.5% interest. They release a new kind of pretzel that turns out very popular ("now with mustard on the inside!"). The added revenue allows the company to pay off some debts, so their credit gets better and Moody's upgrades them from CCC to BBB status. Meanwhile, interest rates overall drop. The company calls the bonds and reissues new bonds that pay just 7% interest, saving them enough money to invest in new kale-flavored pretzels (the Moody's ratings boost made them very confident).
Related or Semi-related Video
Finance: What is Balloon Interest, or a ...196 Views
Finance a la shmoop what is balloon interest or a balloon payment. All right
people you blow and blow and blow and blow and then one day it pops. Well [Balloon with loan written on it explodes]
that's kind of what a balloon loan looks like in most cases common loans are paid [House with a sold sign]
down as they go like a home mortgage on you know your brand-new home there
Well it starts out as 400 grand payable over 30 years and then little by little
grinding away year after year after year the loan is paid down and the final [Years going by and the principal remaining reducing]
payment is like well just a few grand and you're the proud owner of a 30-year
old shack it's become one after 30 years... Well were this a balloon payment style [Picture of a wooden old house]
of loan well you might have just paid interest on that four hundred grand for
twenty nine point nine years and then that last payment would be the four
hundred grand principle you'd borrowed. Huge or as a famous real estate man once
said huge, that could be one month's interest on the four hundred grand plus [Donald Trump appears]
four hundred grand well that last balloon payment will have
popped when you've paid off your house. Well the same structure of debt lives in [Guy pops the balloon with a pin]
the world of zero coupon bonds and t-bills as well where you as an investor
buy a notional par value of say a grand, at a discount meaning you're buying that
thousand dollars at a discount... meaning you pay six hundred forty-two
bucks for a payment of a thousand dollars in six years with no payments of
interest or pay down of principal in between. That final loan payoff is the [Hot air balloons in the background]
balloon oh happy day and it isn't even your birthday [Guy in a suit dancing with balloons and confetti falling]
Up Next
What is the maturity of a bond? Maturity refers to the time when an investment ends. When maturity happens, the investor is either on the hook for...
Why do companies buy back or repurchase their own stock? Companies buy back their own stock because it helps them to increase the value of stock an...