Introduction

A Call Premium is the extra amount paid by a bond issuer to a bondholder when a callable bond is redeemed before its maturity date. This amount is paid over and above the bond’s face value (par) as a compensation for the early termination of the bond and the loss of future interest payments.

Callable bonds are commonly used by corporate issuers and banks, and the call premium serves as a financial safeguard for investors, ensuring that they are partially compensated if the bond is redeemed early—typically during periods of declining interest rates.

What Is a Call Premium?

When a bond includes a call provision, it gives the issuer the right (but not the obligation) to redeem the bond before its stated maturity. If the issuer decides to call the bond, they must repay:

• The face value (usually ₹100 or ₹1,000 per bond), plus
• The call premium – an additional amount (e.g., 1%–3%) over face value.

Example:

If a ₹1,000 face value bond has a 2% call premium, the bondholder will receive ₹1,020 upon early redemption.

Why Do Issuers Call Bonds Early?

The primary reason for early redemption is to reduce borrowing costs:

• If interest rates fall, the issuer may want to replace high-coupon debt with lower-cost debt.
• This is similar to refinancing a loan to get better terms.

Process:

• Issuer exercises the call option.
• Bondholder receives par value + call premium.
• Issuer retires the existing bond and may issue a new bond at a lower interest rate.

Impact on Investors

• Negative for Investors:
• Loss of future interest income.
• Reinvestment risk: Investors may have to reinvest at lower prevailing rates.
• Uncertainty: Callable bonds can be called anytime after the call date, affecting cash flow predictability.

Compensation through Call Premium:

• To make the early redemption less detrimental, issuers pay a premium. This is a built-in incentive that provides some financial relief to the bondholder.

Call Premium in India’s Bond Market

In India, callable bonds are common in:

• Corporate bonds
• Bank capital instruments (e.g., AT-1 and Tier 2 bonds)
• Infrastructure bonds
• State Development Loans (SDLs)

The call premium and call schedule are disclosed upfront in the bond offer document or prospectus. These terms are approved by SEBI or RBI, depending on the type of instrument and issuer.

Call Premium Schedule

Call premiums may decline over time, meaning the earlier the bond is called, the higher the premium:

Such a declining schedule incentivises the issuer to act early if they plan to refinance.

Call Premium vs Yield Impact

While a call premium provides short-term compensation, it can affect the overall yield of the bond:

• If a bond is called early, the yield to call (YTC) becomes relevant instead of yield to maturity (YTM).
• YTC is typically lower than YTM, especially if the bond is called during a falling interest rate environment.

Call Premium vs Put Option (Investor Protection)

While a call option benefits the issuer, some bonds come with a put option, allowing investors to exit before maturity under certain conditions. These two features balance the power between issuer and investor:

• Call Premium protects the investor if the bond is called early.
• Put Option protects the investor by giving them an early exit when needed.

Conclusion

The Call Premium is an important financial feature that protects investors from the downsides of early redemption in callable bonds. It compensates bondholders for the loss of future interest income and helps manage reinvestment risks, particularly during periods of falling interest rates.

For Indian investors, especially those investing in corporate or bank-issued callable bonds, understanding the call schedule and premium terms is critical before making investment decisions. While callable bonds may offer higher initial coupons, their early redemption potential and call premium structure should be factored into the overall risk-return analysis.