CFA Level 1
Fixed Income Investments - Provisions for Redeeming Bonds
The provisions for redeeming bonds are found in the indenture. They can be:
3.Have Prepayment Options and/or
4.Sinking Fund Provisions
1. Call Redemption
By adding a call feature in the indenture, a bond becomes a callable bond. A callable bond gives the issuer the right to redeem the bonds on a stated date or a schedule of dates before the stated maturity date for the bonds arrives.
Let's look at callable bonds in a little more detail. First, some terminology:
- Call Price - This is the price that the issuer will pay the bondholder; also know as the redemption price.
- Call Date - This is the date or dates that the issuer can call the bond from the holders.
- Deferred Call - When a callable bond is originally issued, it is said to have a deferred call of so many years up to the first call date, which is the first day the bond can be called by the issuer.
- Regular or General Redemption Prices - These price tend to be above par until the first par call date. The price is typically known before the redemption occurs.
- Special Prices - These occur because of certain events such as sinking funds, repossessions, forced sales, and eminent domain. These usually occur at par value but could be less, depending on the collateral backing the bonds.
When callable bonds are called, it can be for the entire issue or for just a part of it. A partial call can be done on a random basis, like picking numbers out of a hat, or on a pro rata basis. A pro rata call allows all holders to redeem a certain percentage of their holdings while with a random, partial call it could be anyone's guess as to which bonds will be called by the issuer.
Price can be determined as a fixed price, regardless of dates, based on a predetermined schedule of dates in which price decreases as it nears the bond's maturity date, as well as through a make whole call.
Example: Call Redemption
Let's use the Stone and Co 12's of 20, or Stone and Co 12% bonds of 2020 to illustrate a scheduled call.
Fixed price regardless of date:
This call provision allows the bond to be called at par plus interest at any date past Jan.1, 2010.
Price based on Schedule.
This call provision bases its price on stated dates with the price decreasing as the bond nears maturity.
Jan 1. 2010 Price = 103 or $1,030 based on a par value of 100
Jan 1. 2012 Price = 102 or $1,020 based on a par value of 100
Jan 1. 2015 Price = 101.5 or $1,015 based on a par value of 100
Price based on a Make-Whole Premium
This structure incorporates various formulas that can be structured to develop the price. The formula is structured to protect the yield the investor had been receiving on his bond.