Chartered Market Technician (CMT) Practice Exam

In finance, what does the term 'callable' refer to regarding bonds?

1. The ability to convert into equity

2. The ability to sell back to issuer

3. The issuer's right to repurchase the bond

4. The interest rate risk mitigation

The correct answer is: The issuer's right to repurchase the bond

The term 'callable' in the context of bonds specifically refers to the issuer's right to repurchase the bond before its maturity date. This feature allows the issuer to redeem the bonds at predetermined prices after a specified date, often when interest rates decline or when the issuer has excess cash to pay off debt. This characteristic can be advantageous for issuers because it provides flexibility to refinance debt at lower interest rates, potentially saving money on interest payments. However, it also introduces reinvestment risk for bondholders, as they may have to reinvest their funds at lower prevailing rates if the bonds are called. The other options describe different concepts. The ability to convert a bond into equity pertains to convertible bonds, where bondholders have the option to exchange their bonds for a specified number of shares. Selling back to the issuer isn't typically a feature of bonds, as it would involve the issuer buying back the bonds, which is different from calling them. Interest rate risk mitigation refers to strategies employed to manage risks associated with interest rate fluctuations, but this does not describe the callable feature itself.