Call Feature (or Call Provision)

Call Feature Call Provision Bond Issuer Redemption Call Protection Call Premium Call Price Bonds Indenture
A call feature or call provision is part of the agreement a bond issuer makes with a buyer, detailing the schedule and price of redemptions before maturity. Most corporate and municipal bonds have ten-year call features, while government securities usually do not.
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What is a Call Feature (or Call Provision)?

A call feature, also known as a call provision, is a term in a bond’s indenture (the formal agreement between the bond issuer and the bondholder) that allows the issuer to repurchase the bond at predetermined times before its maturity date. The call feature specifies the conditions under which the issuer can call the bond, including call dates and call prices. This provision grants the issuer the right, but not the obligation, to redeem the bond early, often at a premium to the bond’s face value.

Examples

  1. Corporate Bonds: A corporate bond with a ten-year call provision might allow the issuing corporation to repurchase the bond after ten years at a price slightly above the bond’s par value.
  2. Municipal Bonds: Municipal bonds often have call features to allow municipalities to refinance when interest rates drop, thus reducing their interest expense.
  3. Callable Preferred Stock: Although not a bond, some preferred stocks include a call feature allowing the issuer to repurchase the stock earlier than originally agreed upon.

Frequently Asked Questions

1. What is the purpose of a call feature?

The primary purpose of a call feature is to provide the issuer with flexibility to refinance debt if interest rates decline, enabling them to reduce their overall interest expenses.

2. What is call protection?

Call protection refers to the period during which a bond cannot be called by the issuer. For most corporate and municipal bonds, this period typically lasts for the first ten years after the bond’s issuance.

3. What is a call premium?

A call premium is the amount above the bond’s face value that the issuer must pay to bondholders if it chooses to call the bond before maturity.

4. How does a call feature affect bondholders?

A call feature can be unfavorable for bondholders because the bond might be called in a declining interest rate environment, reducing the potential for further interest income.

5. Are government securities usually callable?

Most government securities, such as U.S. Treasury bonds, do not have call features, making them less flexible for the issuer but more predictable for investors.

  1. Indenture: The formal agreement between the bond issuer and the bondholders, detailing the terms of the bond issue.
  2. Call Premium: The extra amount over the bond’s face value that must be paid by the issuer when calling the bond before maturity.
  3. Call Price: The price at which a bond can be redeemed by the issuer before maturity, typically above the bond’s par value.
  4. Par Value: The face value of a bond, which the issuer agrees to repay the bondholder at maturity.
  5. Yield to Call (YTC): The total return anticipated on a bond if it is called before maturity.

Online Resources

Suggested Books for Further Studies

  1. “Investing in Fixed Income Securities” by Gary Strumeyer
  2. “Bonds: The Unbeaten Path to Secure Investment Growth” by Hildy Richelson and Stan Richelson
  3. “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
  4. “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau

Fundamentals of Call Features: Finance Basics Quiz

### What is a call provision? - [ ] A promise for additional interest - [x] The right of the issuer to repurchase bonds before maturity - [ ] An option for bondholders to sell back bonds - [ ] A clause that increases coupon rates over time > **Explanation:** A call provision gives the issuer the right to repurchase bonds before their maturity date under specific conditions. ### How does a call provision benefit the issuer? - [x] Allows refinancing of debt at lower interest rates - [ ] Provides fixed returns to investors - [ ] Guarantees higher interest payout - [ ] Increases bond default risk > **Explanation:** A call provision is beneficial to the issuer as it allows refinancing at lower interest rates, reducing overall interest expenses. ### What is call protection? - [x] A period during which a bond cannot be called - [ ] Legal insurance for bondholders - [ ] Interest rate guarantee for bond's life - [ ] High penalty period for bond calling > **Explanation:** Call protection refers to the period when the issuer cannot call the bond, usually the first ten years for corporate and municipal bonds. ### What signifies a call premium? - [ ] Lower interest payout - [x] The extra amount paid over the face value when the bond is called early - [ ] Redemption at face value before maturity - [ ] Call protection duration > **Explanation:** The call premium is the extra amount the issuer must pay over the bond’s face value when calling the bond early. ### What does a call price include? - [x] Face value of the bond plus any call premium - [ ] Discounted value of future coupons - [ ] Only the face value of the bond - [ ] Accumulated interest > **Explanation:** The call price includes the bond’s face value plus any call premium that compensates for early redemption. ### How might bondholders be disadvantaged by a call feature? - [x] Redeemed bonds might lead to lower interest income if reinvested at lower rates - [ ] Protects them against inflation - [ ] Improves bond pricing - [ ] Guarantees long-term income stream > **Explanation:** Bondholders might lose further interest income if bonds are redeemed early and reinvested at lower interest rates. ### What is Yield to Call (YTC)? - [x] Total anticipated return on the bond if it is called before maturity - [ ] The yield of the bond if held to maturity - [ ] Interest payment frequency - [ ] Call protection period profitability > **Explanation:** Yield to Call (YTC) measures the total return an investor can expect if the bond is called prior to maturity. ### For which type of bonds are call features most common? - [ ] U.S. Treasury bonds - [ ] Investment-grade corporate bonds - [x] Corporate and municipal bonds - [ ] Penny stocks > **Explanation:** Call features are most common in corporate and municipal bonds. ### What term describes the document detailing the call provision? - [x] Indenture - [ ] Yield spread - [ ] Prospectus - [ ] Municipal note > **Explanation:** The indenture is the formal agreement that includes the call provision details. ### Are government securities typically callable? - [x] No, most government securities are not callable - [ ] Typically, yes, to manage national debt - [ ] Only municipal bonds are callable - [ ] Government securities cannot have call features > **Explanation:** Most government securities, like U.S. Treasury bonds, do not have call features.

Thank you for engaging with our deep dive into call features and mastering your understanding of this essential financial term. Keep expanding your expertise!

Wednesday, August 7, 2024
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