Call Privilege

  

"Membership has its privileges," American Express ads used to tell us. Certain bond issuers also have privileges...specifically, the privilege of calling in their bonds before the maturity date if interest rates in the market go down.

Known as callable bonds, the issuer will clearly state what the possible call dates will be and the amount of extra premium they will pay to make up for the lost interest the holder would have received if the bonds had gone to maturity. Callable bonds usually start out offering a higher interest rate than bonds of similar risk.

Example: The city of Flint, Michigan needs additional funds to continue replacing water pipes that became corroded with lead. So, they issue a $5,000 callable bond with a 6% coupon (interest payment) and a maturity date of January 1, 2028. However, there's a call date of September 30, 2022 with a call price of $5,060. Because this bond issue has a call date, the 6% interest is probably better than what is being offered by similar-risk bonds and maturity dates.

Suppose that in the summer of 2022 interest rates in the market tank, so the city of Flint decides to call in the 6% bonds and issue 4% bonds. They will pay their investors a premium of $60 as a call price per bond ($5,060 - $5,000) to help make up for missing out on the higher interest rate for four years. Flint wants to refinance their higher interest bonds for lower interest ones in order to incur less debt. Also, when interest rates go down, the price of a bond goes up, so the city can most likely issue new bonds at a lower interest rate and get a higher price.

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Finance: What is Forced Conversion?58 Views

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Finance allah shmoop what is forced conversion Okay this is

00:08

forced conversion Yeah this is also forced conversion and so's

00:14

this Yeah that is the issuer of this particular bond

00:19

Like the company who borrowed money has the right as

00:22

described in the indenture to force you to convert the

00:25

bond either into and say twenty five shares of common

00:28

stock or something else Which sort of implies that a

00:31

stock price the over under price of breaking evens about

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forty bucks a share takes you get that thousand dollars

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divided by the twenty five shares Think it's you forty

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bucks a share or the issuer or company who sold

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the bond in the first place can simply call the

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bond and force converted into cash for the small conversion

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premium of ah two point five percent or that's twenty

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five bucks in this thousand dollars par value bond So

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in this sense essentially the break even Numbers actually 41

01:00

dollars a share not forty there because you get an

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extra little premium bump there if they force you to

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convert the bond or debt into equity Got it We'll

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force conversion in a bond sense is usually something cos

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do when they can either refinance the bond at cheaper

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interest rates or are doing so well operationally that they

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have enough cash Teo just retire their debt They call

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it back They buy it back save the interest charges

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and quick cash toe work doing something else Either way

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it's usually weigh less painful than the other flavour of 00:01:30.926 --> [endTime] forced conversion

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