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Definition: Call Premium
Call Premium is the price paid to buy the call option or the price received to sell an option. Premium is the price above the par value that must be paid while redeeming the callable bond from bondholders.
The buyer of a call option has a right but not obligation to buy an underlying asset, a commodity or financial instrument, at a fixed price at a certain future date or within a range of time period. To purchase the call option, the buyer has to pay a price upfront which is call premium. This is determined in open market with demand and supply conditions. There are more sophisticated models available to determine the premium such as Black Scholes model. It considers the underlying asset’s price, risk free rate, the volatility of asset’s price, the strike price and other factors.
The call premium also comes in picture in case of callable bonds. Companies issue callable bonds to raise funds. If the issuer wants to redeem or repay the bonds before its maturity, it has to pay a premium over and above the par value of bond. The issuer calls or redeems the bonds generally if the interest rates have fallen and he can issue the bonds at lower interest rates. The call premium compensates the bond holder for inconvenience caused due to the disruption in the interest payments and hassle to reinvest the funds.