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Make Whole Call Provision



Definition

A Make Whole Call Provision is a stipulation within a bond contract that allows the issuer to prepay or “call” the bond before its maturity date. In this case, the issuer compensates the bondholder by paying a premium, generally calculated using the present value of remaining interest payments due. This provision protects bondholders by ensuring that they receive at least the same amount they would have earned had the bond been held until maturity.

Phonetic

M – MikeA – AlphaK – KiloE – EchoW – WhiskeyH – HotelO – OscarL – LimaE – EchoC – CharlieA – AlphaL – LimaL – LimaP – PapaR – RomeoO – OscarV – VictorI – IndiaS – SierraI – IndiaO – OscarN – November

Key Takeaways

  1. A Make Whole Call Provision serves as a protection for bondholders by allowing the issuer to redeem a bond before it reaches maturity, but only while compensating bondholders for the remaining interest payments and principal amount.
  2. It helps issuers reduce their interest expenses, if the market rates fall, while also providing bondholders with the reassurance that they will not lose out on the interest payments they are entitled to.
  3. Since the provision often leads to a higher bond price, it can be seen as a disadvantage for issuers, as they need to pay more to redeem the bonds early, slightly offsetting the potential gains they could make through refinancing.

Importance

The Make Whole Call Provision is an important aspect in the realm of business and finance as it provides issuers of bonds with a flexible mechanism to efficiently restructure their debts or reduce their cost of capital. This provision enables the issuer to repay the outstanding bonds before their maturity date by compensating bondholders for the net present value of future interest payments they would have received, had the bonds not been called. Essentially, it helps protect bondholders from potential loss of income, as they are “made whole” in the transaction. Ultimately, the Make Whole Call Provision enables businesses to take advantage of favorable market conditions or new financial opportunities to optimize their capital structure, thereby promoting organizational growth and financial stability.

Explanation

A Make Whole Call Provision serves as a protective measure for bondholders whenever a bond issuer decides to pay off the debt prematurely. This provision ensures that the investor receives an appropriate compensation that covers the present value of the future interest payments they would have received if the bond were held to maturity. The purpose of this provision is to maintain the bondholder’s initial expectations of the bond’s yield, reducing risks associated with early redemption, and creating a more appealing investment option. Essentially, this gives the bondholder the assurance that they will not take a financial loss if the issuer opts to redeem the bonds before their term ends. The Make Whole Call Provision is particularly beneficial to investors in an environment where interest rates are expected to decline or have already dropped. When issuers have access to cheaper borrowing costs, they are more likely to refinance their existing debt, leading them to call back the bonds. In such cases, bondholders can reinvest the funds received from the make whole call into other investment options offering similar yields. On the other hand, this provision discourages issuers from engaging in early call activities as the costs associated with refinancing the debt may outweigh the benefits of lower interest rates. Consequently, this fosters a more stable and predictable bond market, providing benefits to both issuers and investors alike.

Examples

A Make Whole Call Provision is a clause included in bond agreements that allows the issuer to redeem bonds before their maturity date. The issuer pays a premium to bondholders, compensating them for the remaining interest payments they would have received until the bond’s maturity date. Here are three real-world examples: 1. In 2017, Apple Inc. issued a series of bonds totaling $7 billion. One of these bonds, a $1 billion 3.85% tranche due in 2027, included a Make Whole Call Provision. In November 2020, Apple decided to exercise this provision and redeem these bonds early, as they wanted to take advantage of lower interest rates to refinance their debt. Apple paid a premium to bondholders, compensating them for the remaining interest payments they would have received until the bond’s maturity date in 2027. 2. In 2013, Verizon Communications Inc. issued a series of bonds worth $49 billion to finance its acquisition of Vodafone’s stake in Verizon Wireless. Some of the tranches of this historic bond offering had Make Whole Call Provisions. In September 2017, Verizon announced its intention to redeem $3.15 billion of the bonds issued in 2013 by using the Make Whole Call Provision to refinance at a lower interest rate. Bondholders were compensated with a premium for the early redemption of their bonds. 3. In January 2019, IBM issued a series of bonds totaling $20 billion to help finance its acquisition of Red Hat Inc. One of these bonds, a 3.25% tranche due in 2029, included a Make Whole Call Provision. If IBM decides to redeem this bond early to take advantage of lower interest rates or for other strategic reasons, the company would pay bondholders a premium, compensating them for the remaining interest payments they would have received until the bond’s maturity date in 2029.

Frequently Asked Questions(FAQ)

What is a Make Whole Call Provision?
A Make Whole Call Provision is a clause included in the terms of a corporate bond that allows the issuer to pay off the bond early by compensating bondholders with a premium over the par value. This premium is calculated based on the present value of future coupon payments, thus “making whole” the investors for their anticipated income from the bond.
How is the premium for a Make Whole Call Provision calculated?
The premium is calculated using a predetermined formula that takes into account the present value of remaining coupon payments and the difference between the current market interest rate and the bond’s coupon rate. This ensures that bondholders are fairly compensated for the early termination of their investment.
What are the advantages of including a Make Whole Call Provision in a bond?
For issuers, it offers flexibility in managing their debt obligations by allowing them to retire outstanding bonds early when market conditions are favorable. For investors, it provides additional protection against potential losses due to early bond repayment, as they receive a premium over the bond’s face value.
Why would an issuer exercise a Make Whole Call Provision?
An issuer may choose to exercise the provision when it believes that market interest rates have fallen significantly since the bond’s issuance, making it more cost-effective to refinance the debt with new, lower-interest bonds. This step can help the company reduce its interest expenses and improve its overall financial health.
How does a Make Whole Call Provision differ from a traditional call provision?
In a traditional call provision, the issuer can redeem the bond early at a predetermined call price, which is usually set at a fixed percentage above the bond’s face value. A Make Whole Call Provision, on the other hand, calculates the call price based on the present value of future coupon payments, ensuring that investors are adequately compensated for the early termination of their bonds.
How does a Make Whole Call Provision impact the value of a bond?
The inclusion of a Make Whole Call Provision often results in a higher yield for the bond because investors demand a higher return for the potential risk of having their bonds called early. However, the provision also adds an element of protection for bondholders, as they are assured compensation that fully accounts for their expected income from the bond.
How common are Make Whole Call Provisions in corporate bonds?
Make Whole Call Provisions have become increasingly popular among corporate bond issuers in recent years. While they were once a rare feature in bonds, they are now commonly found in both investment-grade and high-yield bonds, as they provide benefits for both issuers and investors.

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