Calling - Callable Bonds

On the face of a bond some issuers state that they have the right to retire or call the bond before its maturity.  This generally takes place in deflationary periods.  If, for example, the U.S. was in a high inflation period, a company might issue a 30 year bond at 8%.  If the market 10 years down the road cooled off and comparable new bonds were being issued at a 4% interest rate, then the company would call the 8% bonds, and reissue 4% bonds.  Most bonds also have a provision that they cannot be called for a certain period of time, which can be five or 10 years.  If a bond has a call provision, it generally has a slightly higher annual yield to compensate the buyer if the bond should be called.  The call provision will spell out the first call date and whether the bond will be called at par or slightly above par value.

Many companies set up, and regularly put aside, money in a "Sinking Fund".  These funds are then used to redeem or buy back securities or preferred stock.  Bonds are generally called at par value, so a bondholder who might have paid a premium for the bond could lose money.

 

Convertible Bonds

These are bonds that can be swapped for the same company’s common stock at a fixed ratio, providing a specified amount of bonds for a specified number of shares of stock.  The terms are outlined when the bond is issued.  Some investors like the ability to convert since, IF the price of the stock rises enough you can profit by swapping your bonds for stock.  However, Convertible Bonds are normally offered at a slightly lower rate than a regular bond, since you have the option to "convert" the bond to stock.  If the stock price fails to rise or goes down, you will lose money on convertibles.  Because convertible bonds can be converted to stocks, they tend to be more closely in sync with the stock market versus the bond market.  These are very complicated securities.

 

Zero Coupon Bonds

Zero coupons bonds do not pay interest during the life of the bond, but instead offer the purchaser a substantial discount compared to the face value of the bond.  Thus, the investor’s income comes only from the increase in value of the bond.  There are complicated tax consequences of these bonds, so consult a tax specialist to see if these are appropriate for you.  These may be secured or unsecured.