Call Premium

What Is Call Premium?

Call premium is the dollar amount over the par value of a callable debt security that is given to holders when the security is reclaimed right on time by the issuer.

The call premium is likewise called the redemption premium. In options phrasing, the call premium is the amount that the purchaser of a call option must pay to the writer.

How Call Premium Works

The call premium is an amount over the face value of the security and is paid if the security is reclaimed before the scheduled maturity date. Put another way, the call premium is the difference between the call price of the bond and its stated par value.

Most corporate bonds and preferred shares have call provisions that permit the security issuer to reclaim the securities before they mature. Securities that have this feature are alluded to as callable securities. At the point when a bond is callable, the issuer has the option to call in the bonds when interest rates decline.

The existing bonds will be reclaimed early and the issuer exploits the appealing lower interest rates in the markets by refinancing its debt issue. In effect, the issuer repurchases the higher coupon paying bonds, and reissues bonds with lower coupon rates. This effectively decreases the organization's cost of borrowing.

While this is good for the bond issuer, it opens bondholders to reinvestment risk — the risk of reinvesting their funds in a lower interest-paying bond. Moreover, bonds that are reclaimed early stop making interest payments to bondholders. For instance, an investor holding a 10-year bond that is called following four years won't receive coupon payments for the excess six years after the bond is reclaimed. To remunerate callable security holders for the reinvestment risk they are presented to and for denying them of future interest income, issuers will typically pay a call premium.

Special Considerations

For noncallable bonds or for a bond recovered during its call protection period, the call premium is a penalty paid by the issuer to the bondholders. During the initial not many years that a call is permitted, the premium is generally equivalent to one year's interest. Contingent upon the terms of the bond agreement, the call premium progressively declines as the current date moves toward the maturity date. At maturity, the call premium is zero.

Types of Call Premium

Other than a call premium for callable securities, there is a call premium connected with options. A call option is a financial contract that gives the buyer the right to purchase the underlying shares at an agreed price. The call premium is the price paid by the buyer to the seller (or writer) to acquire this right.

For instance, an investor purchases a Jan. 20, 2023, call option on Apple (AAPL) with a strike price of $180. If by Jan. 20, the stock price transcends $180, the investor will exercise their option to purchase 100 shares of Apple at $180 each. Be that as it may, to receive the rights associated with a call option, a call premium must be paid to the seller. In this case, the premium for one Apple $180 call option is $15.65 per share (1 contract = 100 shares). Accordingly, the call [writer](/composing an-option) (seller) received $1,565 ($15.65 x 100 shares). For this transaction to be productive for the purchaser of the call, in any case, the price of Apple at contract expiration must be above $195.65 per share to account for the premium paid ($180 + $15.65). This is alluded to as the breakeven price.

Features

• Bonds, preferred shares, and other callable securities are generally called when interest rates fall.
• Call premium is the amount better than expected value a debt security owner receives in the event that the security is called early.
• For options, the call premium is the amount paid while buying a call option (i.e., its market price).