Q&A: Early redemption of bonds

September 5, 2008

I paid $980 each for some $1,000 bonds with a 6 percent coupon. They mature in 10 years, but the issuer can call them earlier at face value. The broker's statement shows a 6.3 percent yield to maturity and says the yield will be higher if the bonds are called. How can that be?

Q: I paid $980 each for some $1,000 bonds with a 6 percent coupon. They mature in 10 years, but the issuer can call them earlier at face value. The broker's statement shows a 6.3 percent yield to maturity and says the yield will be higher if the bonds are called. How can that be?

A: Since the bonds have a $1,000 face value, you'll receive $20 more than your $980 cost whenever they're redeemed. The yield-to-maturity calculation takes this "call premium" into account. For example, if the bonds are called after only five years, you'll get the $20 profit sooner, so your yield to call will be almost 6.5 percent. Bond issuers often pay a call premium to compensate investors for possible losses and inconvenience because of early redemption.