What is the Purpose of a Call Provision?

A call provision is a feature that is found in certain types of bond that allows the issuer of the bond to retire it at some point in the future. This type of provision allows the issuer of the bond to repurchase the bond for the original amount of principal, and then cease making interest payments to the investor. Here are the basics of the call provision.

Why Call Provisions Exist

Call provisions are not present with every type of bond. There are only a select few bonds that feature call provisions. When a corporation or government issues a bond with a call provision, it is so that they can have flexibility with their finance arrangement. If a company is locked into a bond term for a fixed number of years, they have to abide by those terms or risk going into default. If the company set up a bond and also puts a call provision into place, they can essentially change the terms of the arrangement at anytime. Instead of having to be locked into paying interest to the investors for 30 years, the company could then pay off the bonds and can save a great deal of money on interest.

Companies will use call provision so that they can keep their financing options open. This is especially true when companies lock in a bond issue at a relatively high interest rate. If interest rates in the market are now low, they can re-issue new bonds and save money on the difference between the interest rates.

How They Work

Call provisions can be set up differently, depending on the entity that is issuing the bond. In most cases, there is a time frame in which the call provision can be utilized. For example, a company might issue a 20 year bond and have a five-year call provision window. This means that during the first five years of the bond, the company could decide to call the bond at any point. If the bond is not called within that window, it will then remain in effect for the full 20 years.

Impact on Investors

If you are an investor, purchasing a bond with a call provision can impact you significantly. In order to agree to purchase a bond with a call provision, you need to have some sort of incentive. In most cases, these bonds will have a slightly higher interest rate attached to them. If the bond is called relatively early, it can negatively impact you because you will miss out on all of the interest payments that you would have been eligible to receive. This means that you went through the trouble of purchasing the bond and then you were unable to receive the interest that you had planned on.

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