What is a ‘Make Whole Call (Provision)’
A make whole call provision is a sort of call provision on a bond that allows the bond issuer to pay out the remaining debt before the bond matures Because of the call, the issuer is typically required to make a single lump sum payment to the investor, which is calculated using a formula that takes into account the net present value (NPV) of future coupon payments that will not be paid incrementally as a result of the call, as well as the principal payment that would have been received by the investor at maturity.
Explaining ‘Make Whole Call (Provision)’
The make whole call provisions of a bond are outlined in the bond’s indenture. In the 1990s, bond indentures started to contain these protections as a standard feature. The majority of the time, issuers do not anticipate having to employ this sort of call provision, and make whole calls are seldom used in practice. If, on the other hand, an issuer decides to exercise its make whole call provision on a bond, investors will be reimbursed, or made whole, for the remaining payments and principal from the bond, as specified in the bond’s indenture.
Payment to Investors
In a make whole call, the investor gets a lump sum payment from the issuer equal to the net present value (NPV) of all of the future cash flows of the bond as agreed upon in the indenture, less any fees and expenses. A classic example of this is the bond’s remaining coupon payments linked with the make whole call provision, as well as the bond’s face value principal payment. When an investor takes use of a make whole call provision, a lump sum payment is made equal to the net present value (NPV) of the future installments as agreed upon in the make whole call provision included within the indenture. The net present value (NPV) is determined using the market discount rate.
Exercising a Make Whole Call Provision
While make whole call provisions may be costly to execute since they require a one-time payment in full, corporations who employ make whole call provisions often do so because interest rates have down. Companies have an additional incentive to exercise make-whole call provisions in an interest rate environment where rates have declined or are on the verge of falling further. If interest rates have fallen, corporate bond issuers will be able to issue new bonds at a lower rate of interest, resulting in fewer coupon payments to their bond holders.
Further Reading
- Indexing a bond’s call price: an analysis of make-whole call provisions – www.sciencedirect.com [PDF]
- Are make-whole call provisions overpriced? Theory and empirical evidence – papers.ssrn.com [PDF]
- Make-whole call provisions: A case of “much ado about nothing?” – www.sciencedirect.com [PDF]
- Setting the optimal make-whole call premium – www.tandfonline.com [PDF]
- What Is the Cost of Financial Flexibility? Theory and Evidence for Make‐Whole Call Provisions – onlinelibrary.wiley.com [PDF]
- Does the choice between fixed price and make whole call provisions reflect differential agency costs? – www.sciencedirect.com [PDF]
- Future investment opportunities and the value of the call provision on a bond – www.jstor.org [PDF]
- A Reduced-Form Model for Valuing Bonds with Make-Whole Call Provisions – www.tandfonline.com [PDF]
- The Life Cycle of Make-Whole Call Provisions – papers.ssrn.com [PDF]
