A redeemable bond is a type of bonus that allows the transmitter its redemption or amortization before its due date.
When we invest in obligations or bonds, we can keep them until expiration
or sell them to another investor in the Secondary market. But these financial
products are amortized on their maturity date.
However, in this case, we are facing one that has a peculiarity,
and that is that the issuer reserves the right to recover it before the agreed
date. In this way, the payment of interest is avoided when the situation in the
market is not favorable.
How a Redeemable bond works
Its operation is relatively simple. The issuer offers them on
the market as would be traditional bonds. If the investor is interested in
them, he buys them knowing that the issuer reserves the right to redeem them
before maturity.
To avoid the damage that early amortization entails for those who buy it, a
performance elderly. In this way, financial compensation offers an incentive
over the traditional ones, which are amortized on the scheduled date.
Amortization forms
There are three ways to redeem a callable bond.
1. Sinking fund swap: This is done according to a schedule
previously established between the parties.
2. Optional exchange: The issuer reserves the option to exchange
it or not at maturity.
3. Extraordinary exchange: When certain causes occur, provided
for in the agreement, allow the issuer to cancel it before expiration.
Advantages and Disadvantages of the Redeemable Bonus
Here are two pros and cons
· An advantage for the issuer is the possibility of redeeming it
before maturity if the market turns unfavorable. This has a drawback: it must
offer a higher interest rate to the investor.
· Another advantage is that, on many occasions, it is cheaper
than a bank loan; that is, it has a little financial cost. However, the
drawback is that the company will have fewer financing options if it does not
have recognized prestige.
Types of redeemable bonus
We have two types of redeemable bonuses.
· On the one hand, those issued by public administrations will
work the same as those about interest, amortization, or general conditions.
· Those who emit private companies. In this case, the same thing
happens; they are similar to the traditional ones in terms of their conditions.
Redeemable bond example
To finish, let’s see this simple example to understand what has
been exposed. We have a 10-year, 100-million-dollar bond with an annual interest
rate of 5% and an amortization premium of 102%.
The company pays $5 million in interest each year (100*5%). Then
these go down the following year to 3%, and the company amortizes the bonds,
returning 102 million dollars (100*102%). It borrows that Money from the bank
at that 3% market interest rate.
As we can see, using a callable bond allows you to pay 3% interest on that 102 million dollar of the loan, that is, 3.06 million dollars. We can verify that this amount is much less than he paid before 5 million.
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