Partial Redemption
Categories: Bonds
Bob Marley’s “Redemption Song” asks us to emancipate ourselves from mental slavery. That’s a great goal and all, but we’d like to offer an alternative: the “Partial Redemption Song,” in which investors emancipate themselves from a portion of their investment.
Like...let’s say Timmy has $50,000 invested in AppWow, a flashy new tech company. While he normally loves living dangerously, the company’s stock has been a little too volatile for his liking lately, so he decides to sell 50% of his shares and invest the money elsewhere. This is what we call a “partial redemption:” we’re only liquidating—or redeeming—part of our investment.
Investors aren’t the only ones who can get in on partial redemption fun, though. Let’s say AppWow issued a bunch of callable bonds to fund R&D for their new app lineup. Since they’ve issued those bonds, though, interest rates have gone down. They’d really love to redeem some of them and then reissue them at the lower interest rate, so they offer to buy back 30% of what they’d issued prior to their maturity date. To sweeten the deal, they’ll also pay a premium to bondholders who take them up on the offer. Since callable bonds usually pay a slightly higher interest rate than noncallable ones, the interest plus the premium might make this partial redemption a very enticing offer.
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Finance: What is call protection, and ho...2 Views
And finance Allah shmoop what is called protection and how
does it work So you wish this term was about
preventing those annoying telemarketers who call you right in the
middle of dinner hoping to sell you X and satellite
subscriptions But it's not Call protection has to do with
a bond being called early meaning that the company that
issued the bond I either company that borrowed the money
is paying at least full par value principle if not
a percent or two premium above that figure when they
call the bond So why would you want protection against
this happening Like isn't it a good thing that bonds
get called back by the people who borrow the money
and then get fully paid off Well the answer No
not always Let's say a bond is issued in a
high interest rate environment like the Fed is trying to
cool inflation so they have short term high interest rates
or high short term borrowing costs That calm six percent
for one year paper eight percent for five year paper
for the best borrowers and a bond you invested in
was yielding two hundred basis points above those U S
government bonds or in this case and say it's five
year paper That's a yielding ten percent But then inflation
cooled and the Fed suddenly lowered rates a lot and
that six percent paper a few years later pays only
four percent and that five year eight percent paper is
now down Teo five percent Well the company that issued
its bond paying ten percent interest could refinance that bond
today at only seven percent interest And they do Right
so they're saving three points of interest Unusually you know
like a billion dollars of Borrow They call the bonds
back home to the mother ship Yep they paid them
all off Maybe with say a two percent premium Big
Woop so that a thousand dollars par unit of the
bond gets one o two or a thousand twenty to
pay it off and retire it well thank you The
investor in that bond who thought you were getting ten
percent a year in interest for a while You can't
even find paper like that in the market The best
you can do of similar risk in duration is only
seven percent so you've lost three percent per year compounded
interest by having those lovely ten percent yielding Bonds called
its protection against this lost yield that bond holders want
and well that's how it works If you'd had bonds
that were uncool a ble or call pretty detected the
company couldn't just buy them back and refinance with cheaper
paper So yeah that's why it's always nice to have
your bonds protected and for even greater security we recommend 00:02:25.28 --> [endTime] investing in a Rottweiler