Redeemable Security
A redeemable security is a type of financial instrument that can be returned or sold back to the issuer in exchange for its principal value within a specified period or on a specific date. This feature allows investors to recover their initial investment, thus providing a degree of security against market fluctuations. Redeemable securities often include bonds, preferred stocks, and mutual funds.
Example
Consider a corporate bond issued by a company to raise capital. This bond has a maturity period of 10 years and offers an annual interest rate of 5%. The company includes a redeemable feature, allowing bondholders to redeem the bond after 5 years. If market interest rates fall below 5%, investors may prefer to hold onto the bond for the entire 10 years to benefit from the higher interest rate. However, if rates rise above 5%, investors might choose to redeem the bond after 5 years to reinvest in higher-yielding instruments.
Similarly, with redeemable preferred shares, a company might retain the option to buy back the shares at a predetermined price after a specific period. This feature can provide shareholders with a predictable exit strategy while allowing the company to manage its capital structure more flexibly.
Why Redeemable Securities Matter
Redeemable securities play a critical role in the financial markets for several reasons:
- Investor Security: The redeemable feature offers investors a way to mitigate risk as they have the option to recover their principal investment, often with interest, within a specific time frame.
- Flexibility: Both issuers and investors benefit from the flexibility that redeemable securities offer. Issuers can manage their debt levels, while investors can adapt to changing market conditions.
- Attractive to Investors: Redeemable securities are often more attractive to conservative investors who seek stable returns without indefinite exposure to market volatility.
- Lower Cost of Capital: Companies can potentially lower their cost of capital by issuing redeemable securities, as they provide investors with an added sense of security, which may result in lower required returns.
Frequently Asked Questions (FAQ)
What is the difference between redeemable and callable securities?
Redeemable and callable securities are similar in that they can both be returned to the issuer. However, the key difference lies in who holds the right to initiate the transaction. With redeemable securities, the investor has the right to sell the security back to the issuer. In contrast, callable securities give the issuer the right to repurchase or ‘call’ the securities before the maturity date. This distinction impacts investor strategy and issuer flexibility differently.
Are redeemable securities beneficial for long-term investors?
Yes, redeemable securities can be beneficial for long-term investors, particularly those seeking a balance between risk and return. The redeemable feature provides a safety net by offering a fixed exit strategy, which can be advantageous in volatile markets. Additionally, knowing that they can recover their principal investment within a specified period can help long-term investors plan their portfolio more effectively.
How do interest rate changes impact redeemable securities?
Interest rate changes can significantly affect the attractiveness and value of redeemable securities. If market interest rates fall below the rate offered by a redeemable security, the security becomes more valuable as it offers a higher return than what is available in the market. Conversely, if market rates rise above the rate of the redeemable security, investors may prefer to redeem the security at the earliest opportunity to reinvest at higher rates, thus increasing the redemption likelihood.
What are some common risks associated with redeemable securities?
Despite their redeemable feature, these securities are not without risks:
- Market Risk: Changes in market conditions can affect the value of redeemable securities, influencing investment decisions regarding redemption.
- Reinvestment Risk: Investors may face the challenge of finding equally attractive investment opportunities upon redemption, especially in a low-interest-rate environment.
- Issuer Default Risk: In cases where the issuer faces financial difficulties, the ability to redeem the security might be compromised.
- Opportunity Cost: Holding redeemable securities may result in missed opportunities for higher returns available in other investments, particularly if the security is held until maturity in a rising interest rate environment.
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- Title 17 —Commodity and Securities Exchanges
- Chapter II —Securities and Exchange Commission
- Part 270 —Rules and Regulations, Investment Company Act of 1940
- § 270.22c-1
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URL https://www.ecfr.gov/current/title-17/part-270/section-270.22c-1 Citation 17 CFR 270.22c-1 Agency Securities and Exchange Commission
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15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 1681w(a)(1), 6801-6809, 6825, and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted. Section 270.0-1 also issued under sec. 38(a) (15 U.S.C. 80a-37(a)); Section 270.0-1(a)(7) is also issued under 15 U.S.C. 80a-10(e); See Part 270 for more
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§ 270.22c-1 Pricing of redeemable securities for distribution, redemption and repurchase.
( a ) No registered investment company issuing any redeemable security, no person designated in such issuer’s prospectus as authorized to consummate transactions in any such security, and no principal underwriter of, or dealer in, any such security shall sell, redeem, or repurchase any such security except at a price based on the current net asset value of such security which is next computed after receipt of a tender of such security for redemption or of an order to purchase or sell such security: Provided, That:
( 1 ) This paragraph shall not prevent a sponsor of a unit investment trust (hereinafter referred to as the “Trust”) engaged exclusively in the business of investing in eligible trust securities (as defined in Rule 14a-3(b) (17 CFR 270.14a-3(b))) from selling or repurchasing Trust units in a secondary market at a price based on the offering side evaluation of the eligible trust securities in the Trust’s portfolio, determined at any time on the last business day of each week, effective for all sales made during the following week, if on the days that such sales or repurchases are made the sponsor receives a letter from a qualified evaluator stating, in its opinion, that:
( i ) In the case of repurchases, the current bid price is not higher than the offering side evaluation, computed on the last business day of the previous week; and
( ii ) In the case of resales, the offering side evaluation, computed as of the last business day of the previous week, is not more than one-half of one percent ($5.00 on a unit representing $1,000 principal amount of eligible trust securities) greater than the current offering price.
( 2 ) This paragraph shall not prevent any registered investment company from adjusting the price of its redeemable securities sold pursuant to a merger, consolidation or purchase of substantially all of the assets of a company which meets the conditions specified in § 270.17a-8.
( 3 ) Notwithstanding this paragraph (a), a registered open-end management investment company (but not a registered open-end management investment company that is regulated as a money market fund under § 270.2a-7 or an exchange-traded fund as defined in paragraph (a)(3)(v)(A) of this section) (a “fund”) may use swing pricing to adjust its current net asset value per share to mitigate dilution of the value of its outstanding redeemable securities as a result of shareholder purchase or redemption activity, provided that it has established and implemented swing pricing policies and procedures in compliance with the paragraphs (a)(3)(i) through (v) of this section.
( i ) The fund’s swing pricing policies and procedures must:
( A ) Provide that the fund must adjust its net asset value per share by a single swing factor or multiple factors that may vary based on the swing threshold(s) crossed once the level of net purchases into or net redemptions from such fund has exceeded the applicable swing threshold for the fund. In determining whether the fund’s level of net purchases or net redemptions has exceeded the applicable swing threshold(s), the person(s) responsible for administering swing pricing shall be permitted to make such determination based on receipt of sufficient information about the fund investors’ daily purchase and redemption activity (“investor flow”) to allow the fund to reasonably estimate whether it has crossed the swing threshold(s) with high confidence, and shall exclude any purchases or redemptions that are made in kind and not in cash. This investor flow information may consist of individual, aggregated, or netted orders, and may include reasonable estimates where necessary.
( B ) Specify the process for how the fund’s swing threshold(s) shall be determined, considering:
( 1 ) The size, frequency, and volatility of historical net purchases or net redemptions of fund shares during normal and stressed periods;
( 2 ) The fund’s investment strategy and the liquidity of the fund’s portfolio investments;
( 3 ) The fund’s holdings of cash and cash equivalents, and borrowing arrangements and other funding sources; and
( 4 ) The costs associated with transactions in the markets in which the fund invests.
( C ) Specify the process for how the swing factor(s) shall be determined, which must include: The establishment of an upper limit on the swing factor(s) used, which may not exceed two percent of net asset value per share; and the determination that the factor(s) used are reasonable in relationship to the costs discussed in this paragraph. In determining the swing factor(s) and the upper limit, the person(s) responsible for administering swing pricing may take into account only the near-term costs expected to be incurred by the fund as a result of net purchases or net redemptions that occur on the day the swing factor(s) is used, including spread costs, transaction fees and charges arising from asset purchases or asset sales resulting from those purchases or redemptions, and borrowing-related costs associated with satisfying redemptions.
( ii ) The fund’s board of directors, including a majority of directors who are not interested persons of the fund must:
( A ) Approve the fund’s swing pricing policies and procedures;
( B ) Approve the fund’s swing threshold(s) and the upper limit on the swing factor(s) used, and any changes to the swing threshold(s) or the upper limit on the swing factor(s) used;
( C ) Designate the fund’s investment adviser, officer, or officers responsible for administering the swing pricing policies and procedures (“person(s) responsible for administering swing pricing”). The administration of swing pricing must be reasonably segregated from portfolio management of the fund and may not include portfolio managers; and
( D ) Review, no less frequently than annually, a written report prepared by the person(s) responsible for administering swing pricing that describes:
( 1 ) Its review of the adequacy of the fund’s swing pricing policies and procedures and the effectiveness of their implementation, including the impact on mitigating dilution;
( 2 ) Any material changes to the fund’s swing pricing policies and procedures since the date of the last report; and
( 3 ) Its review and assessment of the fund’s swing threshold(s), swing factor(s), and swing factor upper limit considering the requirements of paragraphs (a)(3)(i)(B) and (C) of this section, including the information and data supporting the determination of the swing threshold(s), swing factor(s), and swing factor upper limit.
( iii ) The fund shall maintain the policies and procedures adopted by the fund under this paragraph (a)(3) that are in effect, or at any time within the past six years were in effect, in an easily accessible place, and shall maintain a written copy of the report provided to the board under paragraph (a)(3)(ii)(C) of this section for six years, the first two in an easily accessible place.
( iv ) Any fund (a “feeder fund”) that invests, pursuant to section 12(d)(1)(E) of the Act (15 U.S.C. 80a-12(d)(1)(E)), in another fund (a “master fund”) may not use swing pricing to adjust the feeder fund’s net asset value per share; however, a master fund may use swing pricing to adjust the master fund’s net asset value per share, pursuant to the requirements set forth in this paragraph (a)(3).
( v ) For purposes of this paragraph (a)(3):
( A ) Exchange-traded fund means an open-end management investment company (or series or class thereof), the shares of which are listed and traded on a national securities exchange, and that has formed and operates under an exemptive order under the Act granted by the Commission or in reliance on an exemptive rule adopted by the Commission.
( B ) Swing factor means the amount, expressed as a percentage of the fund’s net asset value and determined pursuant to the fund’s swing pricing policies and procedures, by which a fund adjusts its net asset value per share once a fund’s applicable swing threshold has been exceeded.
( C ) Swing pricing means the process of adjusting a fund’s current net asset value per share to mitigate dilution of the value of its outstanding redeemable securities as a result of shareholder purchase and redemption activity, pursuant to the requirements set forth in this paragraph (a)(3).
( D ) Swing threshold means an amount of net purchases or net redemptions, expressed as a percentage of the fund’s net asset value, that triggers the application of swing pricing.
( E ) Transaction fees and charges means brokerage commissions, custody fees, and any other charges, fees, and taxes associated with portfolio asset purchases and sales.
( b ) For the purposes of this section,
( 1 ) The current net asset value of any such security shall be computed no less frequently than once daily, Monday through Friday, at the specific time or times during the day that the board of directors of the investment company sets, in accordance with paragraph (d) of this section, except on:
( i ) Days on which changes in the value of the investment company’s portfolio securities will not materially affect the current net asset value of the investment company’s redeemable securities;
( ii ) Days during which no security is tendered for redemption and no order to purchase or sell such security is received by the investment company; or
( iii ) Customary national business holidays described or listed in the prospectus and local and regional business holidays listed in the prospectus; and
( 2 ) A “qualified evaluator” shall mean any evaluator which represents it is in a position to determine, on the basis of an informal evaluation of the eligible trust securities held in the Trust’s portfolio, whether—
( i ) The current bid price is higher than the offering side evaluation, computed on the last business day of the previous week, and
( ii ) The offering side evaluation, computed as of the last business day of the previous week, is more than one-half of one percent ($5.00 on a unit representing $1,000 principal amount of eligible trust securities) greater than the current offering price.
( c ) Notwithstanding the provisions above, any registered separate account offering variable annuity contracts, any person designated in such account’s prospectus as authorized to consummate transactions in such contracts, and any principal underwriter of or dealer in such contracts shall be permitted to apply the initial purchase payment for any such contract at a price based on the current net asset value of such contract which is next computed:
( 1 ) Not later than two business days after receipt of the order to purchase by the insurance company sponsoring the separate account (“insurer”), if the contract application and other information necessary for processing the order to purchase (collectively, “application”) are complete upon receipt; or
( 2 ) Not later than two business days after an application which is incomplete upon receipt by the insurer is made complete, Provided, That, if an incomplete application is not made complete within five business days after receipt,
( i ) The prospective purchaser shall be informed of the reasons for the delay, and
( ii ) The initial purchase payment shall be returned immediately and in full, unless the prospective purchaser specifically consents to the insurer retaining the purchase payment until the application is made complete.
( 3 ) As used in this section:
( i ) Prospective Purchaser shall mean either an individual contractowner or an individual participant in a group contract.
( ii ) Initial Purchase Payment shall refer to the first purchase payment submitted to the insurer by, or on behalf of, a prospective purchaser.
( d ) The board of directors shall initially set the time or times during the day that the current net asset value shall be computed, and shall make and approve such changes as the board deems necessary.
[44 FR 29647, May 22, 1979, as amended at 44 FR 48660, Aug. 20, 1979; 45 FR 12409, Feb. 26, 1980; 50 FR 7911, Feb. 27, 1985; 50 FR 24763, June 13, 1985; 50 FR 42682, Oct. 22, 1985; 58 FR 49922, Sept. 24, 1993; 81 FR 82137, Nov. 18, 2016; 87 FR 22446, Apr. 15, 2022]
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