What is a make whole call provision and how is it different from normal call option?
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A make-whole call provision is a clause in a bond or loan agreement that requires the borrower to pay a premium to the lender if the borrower decides to repay the debt before its maturity date.
The premium is designed to compensate the lender for any lost interest income that would have been earned if the bond or loan had been held to maturity. The amount of the make-whole premium is typically calculated based on the market interest rate at the time of the call, as well as any other costs or fees associated with the early repayment of the debt.
Make-whole call provisions are often included in corporate bonds or other debt instruments that have a fixed interest rate. These provisions give the borrower the flexibility to refinance or restructure their debt if market conditions change, while also providing the lender with a measure of protection against early repayment.
Make-whole call provisions can be beneficial for both parties, as they provide a clear and predictable method for calculating the premium that must be paid in the event of early repayment. However, they can also make it more expensive for the borrower to refinance or repay their debt, as they must factor in the cost of the make-whole premium in their decision-making process.
It’s important for investors and borrowers to carefully review the terms of any bond or loan agreement that includes a make-whole call provision, and to understand the potential costs and benefits of early repayment.
Make-whole call provision would be beneficial for a borrower??
Yes,
Let’s say a company issues a bond with a fixed interest rate of 5% and a maturity date of 10 years. After a few years, interest rates in the market decline, and the company decides it would like to refinance the bond at a lower interest rate to reduce its debt service costs.
If the bond agreement includes a make-whole call provision, the company can call the bond and pay the make-whole premium to the bondholders to retire the debt early. This allows the company to issue new bonds at a lower interest rate and reduce its overall interest expense.
Without the make-whole call provision, the bondholders would be entitled to receive the full value of the bond plus any accrued interest if the bond is called before maturity, which could be prohibitively expensive for the company to pay. The make-whole call provision provides a predetermined method for calculating the premium that must be paid in the event of early repayment, which gives the company more flexibility to manage its debt and take advantage of favorable market conditions.