Investment bonds are usually issued with fixed interest payments and a fixed maturity date. For example, a company issues a 12-year bond that pays an interest rate of 6%. An investor who buys $100,000 of the bond will receive $6,000 per year and the $100,000 when the bond matures in 12 years. The Company is required to make these payments. To provide flexibility, bond issuers often include call provisions for newly issued bonds. Call conditions allow an issuer to terminate bonds and repay them earlier. Sometimes bonds are due and are highlighted as such in the escrow agreement when they are issued. A bond payable is advantageous to the issuer when interest rates fall, as it would mean repaying existing bonds early and re-issuing new bonds at lower interest rates. However, a bond payable is not an attractive undertaking for bond investors, as it would mean that interest payments would be stopped as soon as the bond was „called“. Strict call protection protects bondholders from having their obligations called before a certain amount of time has elapsed.
For example, the escrow agreement for a 10-year bond could indicate that the obligation remains indisputable for six years. This means that the investor benefits from the interest income paid for at least six years before the issuer can decide to withdraw the bonds from the market. To encourage investment in these securities, an issuer may adopt a call protection provision for bonds. This provision may be a hard call protection, where the issuer cannot invoke the obligation within that period, or a flexible appeal provision, which comes into force after the expiry of the hard appeal protection. If a bond issue has flexible call protection, this provision of the bond comes into force after the expiry of the hard call protection. Flexible call protection is usually a premium to the face value – a value higher than the face value or maturity – that the issuer must pay to recover the bonds before maturity. For example, if the first call date is reached, the issuer may have to pay a 3% premium to call the bonds for the following year, a 2% premium the following year, and a 1% premium if the bonds are called more than two years after the firm call expires. Flexible call protection does not prevent an obligation from being drawn, but it does pay the investor a premium on the face value. The idea behind flexible call protection is to discourage the sender from calling or converting the bond.
However, flexible call protection does not stop the sender if the company really wants to buy the bond. The bond can possibly be drawn, but the provision reduces the risk for the investor by guaranteeing a certain return on the security. A call determination for a bond can be a specific date after which the company can call bonds, so investors must waive them for the principal amount or the amount of principal plus a premium. For example, a 12-year bond may be due after five years. The five years before a bond can be called is called hard call protection. Investors know that they will earn the interest paid by the bond at least until the first date of termination. When buying bonds, the broker usually delivers the return at maturity as well as the return at maturity to show an accurate estimate of the investment potential. A flexible appeal clause increases the attractiveness of a bond payable, which is an additional restriction for issuers if they decide to repay the issue in advance. Callable obligations may include flexible call protection in addition to or in place of hard call protection. A flexible appeal provision requires the issuer to pay a premium at face value to bondholders if the bond is called early, usually after firm call protection is in place.
When investing in bonds with call options, pay attention to when hard call protection expires and the terms of a soft call. Hard call protection starts with issuing the bonds, and if you buy bonds on the secondary market, there may be little time left before call protection expires. This high-yield long-term bond may not be such an attractive investment if it can be called by the issuer in a year or two. Your broker should explain all the calling characteristics of a potential bond investment and what happens when the bond is called. Flexible call protection can be applied to any type of commercial lenders and borrower agreements. Commercial loans may include reduced-rate call provisions to prevent the borrower from refinancing when interest rates fall. The terms of the contract may require the payment of a premium for refinancing a loan within a certain period of time after closing, which reduces the effective return on investment of lenders. Convertible bonds may contain both flexible call provisions and firm call clauses, where the firm call may expire, but the soft clause often has variable maturities. A flexible appeal provision could also indicate that a bond cannot be repaid in advance if it trades above its issue price.
In the case of a convertible bond, the bond`s flexible call provision could highlight that the underlying share reaches a certain level before the bonds are converted. For example, the escrow agreement could stipulate that holders of obligations due will receive 3% of the premium on the first call date, 2% per year after hard call protection, and 1% if the bond is called three years after the expiry of the firm call provision. A flexible call provision is a feature of fixed income securities that comes into effect after the expiry of the firm call protection and provides that the issuer pays a premium in the event of an early redemption. When you buy a bond, the purchase is motivated by the attractive return it yields. When interest rates fall, you want to hold on to the bond and earn the yield for as long as possible. The issuer, on the other hand, would be happy to repay the bond and issue new bonds at a lower interest rate. If a bond is due, the issuer can do so – call and repay your high-yield bond. Protection from hard and soft calls limits the issuer`s ability to recover bonds. A company issues bonds to raise funds, to meet short-term debt obligations or to finance long-term investment projects.
Investors who buy these bonds lend money to the issuer in exchange for periodic interest payments, called coupons, which represent the bond`s return. When the bond matures, the investment is repaid to the bondholders. .