Question

    Which of the following methods of retiring bonds before

    maturity is generally considered the most detrimental to the bondholders?
    A Tender offer Correct Answer Incorrect Answer
    B Call provision Correct Answer Incorrect Answer
    C Sinking fund provision Correct Answer Incorrect Answer
    D Put provision Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    ┬а┬а┬а┬а┬а A bond call provision is a predefined condition on the bond that allows the issuer to retire or repurchase the debt security attached with the financial instrument. Numerous events can trigger a bond call provision, such as the underlying asset reaching a specific target price or a date. However, the most common is the falling market interest rates below the bondтАЩs coupon rate. The bond call provision, when exercised, is referred to as тАШCalling of BondтАЩ. When a bond is called, the issuer pays the accrued interest up to the date of recall and repays the principal amount invested by the bondholder at the time of purchase. The bond call provision is an optional clause on a bond and is pre-informed to the investors that it is callable along with the events that can trigger the calling of the bond. Investors find it risky that the issuer can call the bond anytime, and they would have to sell, reluctantly. Bondholders have to look for new bonds that may come at a considerably lower coupon rate than the current one they were holding.

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