What is a Redeemable Bond?

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The redeemable bond is a bond with the security of payment after a certain period of time known as maturity. These bonds largely fall in the category of redeemable debt. Issuers of redeemable debt issue them for long-term financing. The interest rates and the principal are usually paid back on maturity as pre-informed while selling the bond by the issuer.

How Redeemable Debt Works?

Redeemable debts work well for both issuers and buyers. While issuers get capital financing, the buyers get an increased interest on these bonds.

Most redeemable debts come with a call option. To overcome the risk associated, the issuers call the debt at a slightly higher rate of interest than irredeemable debts.

Types of Redeemable Debts

There are three types of redeemable debts −

  • Optional Redemption − In the case of optional redemption, the issuer enjoys the option to call the debt back. There is a period after which redemption becomes effective is mentioned in such cases.

  • Mandatory redemption − In such cases, the bonds reach redemption on a pre-determined date. Many bands fall under this category.

  • Sinking Funds − The issuers of the bond contribute a portion to a sinking fund to pay the debt back on a given date in future.

Irredeemable Vs Redeemable Debts

Irredeemable debts come with perpetuity. They do not come with a maturity date. The investors in such debts get an interest coupon the rate of which is pre-determined. The issuers cannot redeem the debt without a special clause in such cases.

In redeemable debts, the issuers have the option to call the debt back The issuers can call a part or the full amount back as stated in the clause of the redeemable debts.

Advantages of Redeemable Debts

  • Investors do not have too much risk unless the issuers call it back due to low-interest rates.

  • Payment of fixed interest until the debt reached maturity. The full principal is paid back on maturity.

  • Issuers can raise large amounts of money from markets.

  • The redeemable clause helps the investors stay secured from too low-interest returns.

Disadvantages of Redeemable Debts

  • The interest rate on redeemable debts is low even when it is higher than irredeemable and unsecured debts.

  • Issuers may have to pay higher. For example, premiums may have to be paid by issuers on redemption.

  • Investors face the risk of losing a significant portion of their wealth in the case they invest too much in a redeemable debt and it fails.

  • In the case of redeemable debts, investors are not able to gain higher interest rates with the current debts.

raja
Published on 18-Aug-2021 11:55:07

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