Bond Redemption

Bond redemption is the repayment of principal by the issuer of a bond to its holders, which extinguishes the debt. It most often takes place on the maturity date set when the bond was issued, but the terms may allow or require repayment sooner. Once a bond is redeemed in full, it stops paying interest and is cancelled.

Redemption is a contractual event governed by the conditions of the bond. It differs from a purchase by the issuer in the market, such as a bond repurchase or a bond tender, in which holders choose whether to sell. On redemption, all holders of the affected bonds are repaid on the terms laid down in advance, whether they wish it or not.

The standard case is the bullet bond, repaid in a single amount on its final date. The holder receives the face value together with the last coupon. An amortising bond reaches the same point in stages, with principal returned in instalments over its life. A perpetual bond has no maturity and is repaid only if the issuer exercises a right to call it. The operational handling of the final payment is described under maturity payment processing.

Many bonds can be repaid before maturity. The general topic is covered under early bond redemption; the main forms are:

• Issuer call. A callable bond gives the issuer the right to redeem on or after set dates at set prices, listed in the call schedule. Issuers call bonds when they can refinance more cheaply.
• Make-whole call. The issuer may redeem at any time at a price based on the present value of the remaining payments, discounted at a government bond yield plus a small margin. This compensates holders and is rarely cheap to exercise.
• Investor put. A puttable bond lets the holder demand repayment on dates in the put schedule, or after a specified event such as a change of control.
• Sinking fund. The issuer must retire a set amount each year through a sinking fund, by drawing bonds or buying them in the market.
• Tax and regulatory calls. The issuer may redeem if a change in tax law forces it to gross up payments, or if a capital instrument loses its regulatory treatment.
• Mandatory redemption. Certain events, such as the sale of a secured asset or the failure of an acquisition that the bonds were meant to fund, require repayment.

Bonds may also become repayable immediately if an event of default occurs and the holders or trustee declare them due, which is known as acceleration.

The amount paid is set by the terms. At maturity it is normally par, meaning 100% of the nominal amount. Early redemption by the issuer is often at a premium, the bond call price, which may step down towards par as maturity approaches. Zero-coupon bonds are redeemed early at an accreted value that reflects the discount earned to date. Accrued interest up to the redemption date is paid in addition unless the date coincides with a coupon date.

When only part of an issue is redeemed, the terms specify how holders are selected. In a pro rata redemption, each holding is reduced by the same proportion, either by lowering its nominal amount or by applying a pool factor. In a redemption by lot, individual bonds are drawn at random and repaid in full while others remain outstanding. The depositories run the drawing across participants' holdings, and custodians allocate the result among their clients. See partial bond redemption.

For an optional redemption, the issuer gives notice to holders within the period required by the conditions, commonly between 15 and 60 days before the redemption date. The notice is delivered through the trustee or agent, the clearing systems and, where the bonds are listed, the exchange. It states the redemption date, the price and the amount to be redeemed, and it is generally irrevocable.

Shortly before the date, the issuer transfers the funds to the paying agent, which pays the central securities depository. The depository credits cash to its participants and removes the bonds from their accounts, and custodians do the same for their clients. From the custodian's point of view, a redemption is a mandatory event with no choice for the holder, except where a put must be exercised by sending an instruction before a deadline. The full workflow is described under redemption processing.

For the issuer, redemption removes a liability and ends the interest cost. If bonds are redeemed at a price different from their carrying amount, the difference is recognised as a gain or loss.

For the investor, an early redemption by the issuer usually arrives when interest rates have fallen, so the proceeds must be reinvested at lower yields. This reinvestment risk is the reason callable bonds offer a higher yield than comparable non-callable ones. If the issuer fails to pay on the due date, the bond is in default, and holders' remedies depend on the trust deed or indenture and on insolvency law.