What is a Call Provision in a Bond Agreement?

A call provision is an option built into a bond indenture, allowing the issuer to redeem bonds prior to their scheduled maturity date. In exchange, the issuer pays a premium over the face value of the bonds. The issuer uses this provision when interest rates decline, so that it can re-issue new bonds that offer a lower interest rate. The presence of a call provision makes a bond less valuable to investors, since their ability to earn a high return for a protracted period of time could be curtailed. Consequently, bonds with call provisions typically trade at a higher effective interest rate, to compensate investors for their uncertain future return on investment.

What is a Call Protection Provision?

A call protection provision in a bond indenture protects the interests of investors by not allowing the issuer to redeem bonds until a certain period of time has passed, thereby locking in the investor return through that date range. A call protection provision that delays any possible redemptions to a distant date is more valuable for investors, and so may result in the price of the bond being bid up by investors. However, as the date of the first call provision approaches, the market price of the bond may drift downward, as investors begin to factor in the possibility of an imminent call by the issuer.

Example of a Call Provision

As an example of a call provision, a corporation issues $10 million in 10-year bonds with a 6% interest rate, but includes a call provision allowing it to redeem the bonds after five years at 102% of face value. Five years later, market interest rates have fallen to 4%, so the company decides to call the bonds early. It pays bondholders 102% of the face value, or $10.2 million total, to retire the debt. The company then issues new bonds at the lower 4% rate, reducing its interest expense going forward.