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You need to understand what redemption is. Here’s what to know.

What is redemption?

Redemption is the return of an investor’s principal on a fixed income security such as a bond, mutual fund or preferred stock.

Deeper definition

Fixed income securities offer investors regular fixed payments of interest. The payments and interest are known in advance. When fixed-income securities mature, they are redeemed at par value.

Par value is the security’s face value. Securities can be redeemed at the time of maturity or prior to maturity.

Companies that issue bonds sometimes have the option to stop paying the bonds’ interest rates and repurchase securities before the bonds’ maturity dates.

Redemption value is the price paid to the investor when the issuing company repurchases the security either before or at the maturity date.

When called bonds are redeemed, they are redeemed at a price above par value. The earlier the bond is called by the issuer, the higher the bond’s redemption value.

Redemption examples

Mutual fund companies must repurchase mutual fund shares within seven days of receiving investors’ redemption requests. If an investor has not held a fund for the assigned holding period, he may incur a redemption fee.

Additionally, the investor may be required to pay a back-end load, which is the deferred sales charge. Back-end fees are equal to a percentage of the value of the share being sold. Back-end loads decline over time and usually disappear if the investor has held the fund for five years or longer.

When it comes to preferred stocks, investors have an additional layer of protection. If the company can no longer meet its financial obligations, preferred stockholders can claim assets before common stockholders.

Preferred stock is issued at par value. It pay set dividends at regular intervals. Investors typically redeem preferred stocks within a few dollars of their issue price.

Redeeming investments generates capital gains or losses. Capital losses offset capital gains within the same year. Capital gains are taxed on an annual basis.

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