Hi, I’m new to this forum and I need help with a make whole call provison. I wonder how this provision works. this provision works like a call option, or may vary in different cases. it has to be define in the indenture? Thank you for help
A stipulation in a bond indenture that permits the borrower to redeem a bond prior to maturity by making a lump-sum payment equal to the present value of future interest payments that will not be paid because of the early call. The provision makes the bondholder whole by providing compensation for interest payments that are missed because of an early redemption. It must be clearly defined in the indenture.
Lets do an example. Look at ORCL 4.95 4/15/2013. Bonds were issued 04/09/2008 at 5YR+220 with a make whole call at +35. What this means is that at any time, Oracle could call the bond at the price corresponding to the benchmark treasury, which is T 2.5 03/13 + 35 bps. This would be a terrible deal for the issuer in most markets as the make whole call is often a price signficantly above market. However, with tight spreads and a upward sloping yield curve, the MHC can become signifcant. For instance, this bond currently trades, maybe +40/+35. The offer side is right about where the issuer has a MHC. Some issues have been called at wider spread/lower price than offer side
The idea is to discount the cash flows at an artificially low rate to increase the call price regardless of general interest rate movement. Think of a bank that buys “bonds” as a business (aka it makes loans). In a declining rate environment an issuer (the client) has an incentive to call the bonds and refinance. This leaves the bank with a pile of money they have to put back to work in the lower rate environment. Make whole attempts to compensate them for this risk or prevent the prepay altogether. 1morelevel: have you seen a case in real life where a make whole call was advantageous to the issuer? I’ve never seen one called with MW but I imagine it’d be motivated by something other than the cost/benefit analysis of the bonds themselves. I suppose if spreads were tight it could make sense as a stand alone decision. edited for spelling