Question

Define these business finance terms in your own words and then give a real world example of each: Bond, Bond Rating, Call Provision, Deferred Call Provision, Call Protection, Call Premium.

Answer 1

Bond - A bond is a unit of debt issued by companies or the governmant. The issuer of the bond pays a specified interest to the bondholders and repays the bond at the maturity. For example a company issued certain units of bond with a coupon rate of 5% with face value of $100 to be matured after 10 years. The bondholder will be subject to an annual payment of $5 as interest and will receive $100 at the end of 10 years.

Bond rating - Bond ratings are the grades given to the bonds. These ratings are given by the credit rating agencies. The ratings are given on the basis of the issuer's financial strenght and his capabilty to repay the bond amount and interest payment capacity. For example standard an poor's AAA rating is the best rating given.

Call provision - It is a clause in the bond agreement in which the issuer can call the bonds and allows him to repay the bond before its maturity. For example, a company issued a bond for a period of 10 years, under this clause the company can repay the bond before the maturity of 10 years, let's say after 5years even though the terms hasn't been completed.

Deferred Call provision - It is a provision that prohibits or restricts the company from calling the bond before maturity of a certain period of time. For example, a company issued a bond for a period of 10 years, there is provision which restricts the company from the calling the bonds for say 7 years. This means that for prematurity redemption the company has to wait for 7 years and only after the expiration of 7 years, it can repay befor maturity.

Call protection - It is an indenture in the bond agreements that restricts the issuer from calling the bond back for a specified period of time. For eg if a company issues bond with 10 year maturity in 2010 with coupon of 10%, by the time the interest rate fell to 5% in 2012, and there is call protection till 2015, the company will pay 10% interst till 2015 and can only call back after 2015.

Call premium - It is the amount over and above the maturity price the bond holder receives in case of prematurely redemption. For example a bond with face value of $100 is redeemed prematurely after 5 years at $105, then $5 will be the call premium.