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What is a Redemption Price?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 03 December 2016
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Sometimes referred to as the call price, the redemption price is the amount that an issuer pays if he or she chooses to call or redeem a bond issue or preferred stock prior to the security reaching maturity. Usually, this price is identified in the provisions of the agreement that governs the sale of the bonds or shares of the preferred stock. While there are some exceptions, the redemption price is usually set at a level that ensures the investor recoups the original investment.

As it relates to bond issues, any bond that is structured to allow the issuer to call the bond early will identify a means of arriving at the redemption price. For example, if there is one point during the life of the bond that the issuer can choose to call that bond, the redemption price may be a set amount, assuming the interest rate associated with the bond was fixed. If the bond carries a variable rate, the formula for calculating the price may involve identifying the current prevailing rate of interest, factoring in the amount of time that the investor has held the bond, and adding that amount back to the original purchase price paid by the investor.

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With stock options, the redemption price is usually associated with preferred shares that are issued by an open-end investment company. In this scenario, the issuer may exercise the right to buy back any issued shares from investors, following provisions that are found in the original sales agreement related to the shares. The typical approach is to set the redemption price so that it reflects the net asset value of each share that is bought back, a situation that may or may not provide the investor with some sort of return.

Depending on the circumstances, the redemption price will often allow the investor to recoup his or her original investment, and make at least some profit from the effort. In the case of stock option, there may be some loss involved. When that is the case, exercising the redemption price can at least limit the amount of loss that the investor would ultimately realize if the issuer had not chosen to redeem the security early.

There is no reason to avoid investments that are structured to allow for an early redemption. Investors can and do earn returns on bonds and stock options with this type of provision. Instead, take the time to look at what type of return can reasonably be expected if the issuer chooses to exercise the option to call the security early and the redemption price is invoked. Should the projections indicate that the amount of return is reasonable and that market conditions are likely to be somewhat stable at the time the security is called early, then proceeding with the purchase is a viable option. If the investor does not feel that the call price would yield a return that is worth the effort, then he or she would do well to look for other investment opportunities.

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CBlizzard
Post 3

Preferred stock can only be called back after a pre-determined date. The investor should be aware of this date before they buy the stock. This is the risk of buying preferred stock, after it is callable, you could lose a potential fat revenue stream overnight. However you should also be aware that these stocks often pay a premium because they are callable thus mitigating the risks. It should also be noted that not all preferred stocks can be forcibly called back.

GroundGold
Post 2

@Warhawk, this is the big difference between common stock and preferred stock. Forced call back of stock only occurs in preferred stock. These stocks act more like bonds where the stock holder is guaranteed a set dividend. If the market rate falls, the company needs to be able to callback its stock or else it can go bankrupt by paying large dividends that they are no longer making in the market. The redemption price allows a company to do this while still leaving the investors with their principle plus a little extra in most cases. Companies selling common stock can not usually force a callback of shares as they do not have to pay a set dividend and so, don't need to pay dividends above market earnings.

Warhawk
Post 1

But isn't this illegal? What stops a company from buying back all their stock as soon as they project significant growth?

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