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Definition: Call Provision
A provision that allows the original issuer of a fixed income instrument to buy back (repurchase) part of the debt issue or complete retiring the bond. Usually this call provision stipulates a specific time frame under which the bond can be called. Multiple call dates are mentioned. The price to be paid to bond holders and interest is defined. The call price is usually higher than fair value but decreases as the bond closes maturity. The difference between the call price and fair value is known as call premium.
It is beneficial to the issuer as he can call back the bond in case interest rates have fallen and gain or continues to make interest payments when interest rates rise. The gain materialises as new debt can be issued at lower interest rate instead of making higher repayments on the old debt. As there is a risk associated with a callable bond that it might be called back, they trade at higher returns (lower price) viz a viz comparable non callable bonds. The present a reinvestment risk as interest the decrease might trigger calling of bond and this will lead to retiring of bond at higher interest rate leaving investor with cash to be invested in lower interest rate bonds. Further, call provision also limits the possible price appreciation of a bond as price of a callable bond will be as high as call price only when interest rates fall. As a result, the true return is usually less than yield to maturity for a callable bond.