Question

CALL PROVISIONS[LO1]

A company is contemplating a long-term bond issue. It is debating whether to include a call provision. What are the benefits to the company from including a call provision? What are the costs? How do these answers change for a put provision?

Answer 1

Benefits of the company for including a call provision are as follows-

A. Company will be having a flexibility in order to call its bonds whenever it requires.

B. It can proactively manage its liability in the future and it can predict the liabilities in advance.

C. it can also be managed better with the interest rate fluctuations because it can call its Bonds at the time of the beneficiary interest rate regime.

Cost of the call provision of the bond will be meaning that-

A. These call provisions in mean that the bonds are to be issued at a additional cost to the company because this will be giving an embedded benefits to the company so this will be having an additional costs associated with it.

B. The Call provision will also be meaning that this will be having higher cost to the company because this will be providing the company with the additional benefit of calling this bonds.

Put options are associated with provisions that will allow the holder of the bond right to force the issuer to pay back the principal on the bond and put option will be giving the bondholder the ability to receive the principle of the bond whenever they will want their bonds.

put option will mean that the company will have to their bonds at lower cost and the company will be having advantage in assurance of these bonds at a lower cost but the company will be facing a risk from shareholders perspective that share holder can exercise their rights.