Let’s use an example:

ABC Corporation issues a 20 year bond and will pay an annual interest rate of 5%. The interest rate will be paid quarterly. The bond has a callable feature at 5 years which means that at the 5 year period the bond can be redeemed for the original amount of issue.

The callable feature is only there for the benefit of the bond issuer. If the interest rates are lower than the original interest (5%) then they will redeem the bonds and re-issue at the lower rate. If general interest rate are higher than they will keep the bonds in force. These callable bonds are at the mercy of the bond issuer and will only be for the benefit of the original issuer. This feature is known as the “back door hatch.”

This becomes extremely important when the calculation is done for yield…The yield to call can be substantially lower than the yield to maturity for bonds purchased in the secondary market. A bond purchased above original cost in the secondary bond market will always pay a lower “YIELD” than a bond purchased at the original offering date. This becomes a very important issue when a bond has a callable feature and it is vitally important to always know two things:

1. The yield to maturity

2. The yield to call

It is a strong possibility that a bond with an original issue date earning 5% yield purchased in the secondary market to have a yield to call of much less even a zero yield. The calculation can be done by your broker and it is an essential piece of information to know.

What is your yield to maturity and what is your yield to call? With this information you will be able to make a mature decision whether bonds are an investment which can benefit you.

Bill Broich helps seniors manage their retirement money. Visit his website for additional information: Annuity.com