Call feature definition
/What is a Call Feature?
A call feature is a feature in a bond agreement that allows the issuer to buy back bonds at a set price within certain future time frames. The issuer uses a call feature to hedge against interest rate risk; bonds can be bought back and replaced by bonds carrying a lower interest rate if interest rates decline.
This feature may limit the amount of money that a bondholder might otherwise be able to earn by holding a bond, so investors demand a higher effective interest rate when a call feature is present. To ensure that investors receive a reasonable return on investment, the call feature usually does not begin until a number of years after the bond issuance date.
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Types of Call Features
Here are several examples of call features and their variations:
Optional call. The issuer can call the bond at their discretion after a specific date. For example, a bond with a 10-year maturity may be callable after five years at 102% of its face value.
Make-whole call. Allows the issuer to call the bond at any time by paying the present value of the remaining coupon payments and principal. For example, if interest rates fall significantly, the issuer can retire the bond early without a traditional "call penalty."
Sinking fund call. Requires the issuer to periodically retire a portion of the bonds through scheduled payments. For example, a bond issuer retires 10% of outstanding bonds each year, potentially calling bonds before maturity.
Extraordinary call. Allows the issuer to redeem the bond under specific circumstances, such as project cancellation or asset destruction. For example, a municipality issues a bond for a stadium project but redeems it early if the project is abandoned.
Refunding call. Permits the issuer to call the bond if they can issue new debt at a lower interest rate. For example, a corporation calls a 7% coupon bond early when it can issue new bonds at 5%.
Step-up call. The call price increases at pre-determined intervals to incentivize investors. For example, the issuer can call the bond at 102% after three years or at 105% after five years.
American call option. The issuer can call the bond at any time after a specified date. For example, after five years, the bond can be called on any coupon payment date.
European call option. The bond can only be called on a specific date. For example, a 10-year bond is callable only at the end of the fifth year.
Bermudan call option. Allows the issuer to call the bond on specific dates, such as on coupon payment dates. For example, a bond is callable every six months after an initial lockout period.
Par call. The bond is callable at face value rather than at a premium after a certain date. For example, after 10 years, the bond can be called at 100% of its face value.
These call features affect the bond's yield, pricing, and risk profile, and investors should consider them when evaluating bond investments.