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Redemption value is the amount that an issuer must pay in order to repurchase some type of security before that security reaches its date of maturity. The idea is to determine what price would allow the issuer to make this type of transaction and either minimize the loss or still derive some sort of benefit from the transaction. Bond issues are a common example of investments that may be redeemed at some time before the maturity date.
There is no single way for a company to calculate the redemption value associated with a given investment. A number of factors may come into play, including the amount of time remaining until the security matures, the benefits that will be realized from calling the securities early, and the amount that must be paid out in order to regain control of the securities. Issuers may choose to redeem securities early for several different reasons, including the prospect of saving on the payout of interest or dividends that would apply if investors held the securities until the maturity date.
One way to understand redemption value is to consider a bond issue that is released by a municipality. The bond is structured to provide investors with periodic interest payments over the ten-year life of the bond. Within the terms of the bond contract, the issuer retains the right to call the bond at specific points in the bond’s life, settling with investors according to the provisions that are found within the contract. If the issuer is considering calling the bond after seven years, assessing the price that must be paid to investors, both in terms of principal and any accumulated interest owed as of the date of the bond is called, is necessary. Should the issuer find this would be in the best interests of the municipality and allow it to retire the bond early, diverting the savings into other endeavors to the benefit of the jurisdiction, the redemption value will be considered acceptable.
Investors should also consider the redemption value of investments before actually making a purchase. Doing so makes it easier to determine the level of return that will be achieved if the issuer wishes to redeem the instrument before the agreed upon maturity date. If the earliest opportunity to redeem will not yield a return that the investor considers reasonable, chances are that the investor should forgo the opportunity and seek investments that are more likely to generate the level of return desired.