Make-Whole Call Provision

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on September 07, 2023

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What Is a Make-Whole Call Provision?

Make-Whole Call Provision is a clause in a bond contract that allows issuers to repay debt early. Its purpose is to protect bondholders from the risk of reinvestment at lower interest rates.

When utilized, the issuer repays the bond's principal plus a premium, calculated to cover the present value of future interest payments lost.

This provision is often found in corporate bonds and significantly impacts investors as it reduces their risk but potentially limits their upside if interest rates fall.

Understanding it is essential for bond investors as it influences their potential return and the security of their investment. The provision reflects the complex interplay of interest rates, time, and risk, which are fundamental in financial markets.

Functioning of Make-Whole Call Provisions

Calculation Methods

To compute the Make-Whole call premium, the issuer uses a discount rate equivalent to a similar maturity Treasury yield plus a spread, then multiplies this rate by the remaining coupon payments and principal.

Considerations for Investors

When investing in bonds with an MWC, investors should comprehend the mechanism behind the calculation and the potential impact on their returns. Understanding the risk and return trade-off is crucial in this scenario.

Application in Corporate Bonds

In corporate bonds, the make-whole-call provision works as a protective feature for investors. Issuers have to pay a premium, discouraging them from calling bonds unless it's highly beneficial. This ultimately results in stability for the investors.

Differences Between Make-Whole Call Provisions and Other Call Provisions

Traditional Call Provisions

A traditional call provision permits the issuer to repurchase bonds at a predetermined price after a specified period. In contrast, a make-whole call provision permits the issuer to call the bond at any time, compensating the bondholder for the present value of future interest payments.

Callable and Non-callable Bonds

Callable bonds offer the issuer the right to repay the bond before its maturity. Non-callable bonds do not provide this option. Make-Whole call provisions are callable bonds that offer additional protection to the investor.

Yield-To-Call and Yield-To-Worst

Yield-to-Call calculates the yield assuming that a bond is called at the earliest possible date. Yield-to-Worst calculates the lowest yield, whether it's yield-to-maturity or yield-to-call.

With an MWC, an investor is likely to receive more than the yield-to-call and potentially closer to the yield-to-maturity.

Make Whole Call Provisions vs Other Call Provisions

Pros and Cons of Make-Whole Call Provisions

For Issuers

For issuers, the significant advantage of MWC is the increased flexibility. It provides them with an option to call the bond at any point without waiting for the call date.

On the downside, an MWC often necessitates a premium payment, which might be significantly more than the amount saved from retiring the debt early.

For Investors

Investors gain an increased level of protection, ensuring they are compensated if the issuer calls the bond early.

Investors face reinvestment risk. The received premium must be reinvested, often in a lower interest rate environment.

Pros and Cons of Make Whole Call Provisions

Role of Make-Whole Call Provisions in Bond Pricing

Impact on Bond Value

Making whole call provisions can increase the attractiveness and, therefore, the value of a bond because they offer protection to investors.

Impact on Yield

From the yield perspective, the yield-to-worst method provides a lower bound for the yield, which includes scenarios where the bond is called under a Make-Whole call provision.

Influence on Bond Market Volatility

MWC provisions can potentially reduce market volatility by discouraging the premature calling of bonds, thus maintaining market stability.

Legal and Regulatory Considerations for Make-Whole Call Provisions

Laws and Regulations in the United States

In the U.S., Make-Whole call provisions are governed by contract law. Disputes about these provisions can be taken to court, as evidenced by cases such as the Energy Future Holdings case in 2016.

Laws and Regulations in Europe

In Europe, laws vary from country to country. However, the principle of contractual freedom typically applies, meaning parties are generally free to negotiate the terms of the bond contract, including making whole-call provisions.

Laws and Regulations in Asia

In Asian markets, laws also vary. However, as in the West, bonds are typically governed by the terms of the bond contract and any applicable securities regulations.

Recent Developments and Future Trends of Make-Whole Call Provisions

Trends in Financial Markets

As interest rates remain low globally, it is anticipated that the use of Make-Whole call provisions will continue to increase. They offer an attractive compromise between issuer flexibility and investor protection.

Predicted Future Changes

The continued evolution of the bond markets, including the emergence of green and sustainable bonds, may lead to further innovation and changes in the use of Make-Whole call provisions.

Impact of Technology and AI

Advancements in financial technology and artificial intelligence could influence how Make-Whole call provisions are calculated and managed in the future. For instance, AI could be used to optimize the timing and pricing of bond calls.

Bottom Line

A Make-Whole Call Provision is a crucial part of bond contracts that allows issuers to retire their bonds early by compensating investors for the net present value of future interest payments they would otherwise lose.

This mechanism operates using a benchmark U.S. Treasury rate plus a spread to calculate the premium.

There are advantages and disadvantages to these provisions. For issuers, it offers financial flexibility, but it could also necessitate a significant premium payment.

Investors benefit from the protection offered, as they are assured compensation if the bond is called early. However, they may face reinvestment risk, often resulting in having to reinvest the premium at lower interest rates.

Understanding Make-Whole Call Provisions is essential in corporate finance, assisting both issuers and investors to navigate the intricacies of bond markets.

Make-Whole Call Provision FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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