Question

Describe three optional features of bonds (e.g. call provision) and how they impact bond value.

Answer 1

The most important features of a bond are:

Feature # 1. Repayment of Principal:

Bonds are issued in denomination of $1,000 but there are also bonds of values of $ 500 and $100 and of values as high as $5,000 and $10,000. Financial institutions are known to buy corporate bonds bearing higher values. The value of the bond is called the ‘face value, par value or maturity value’.

The face value of the bond represents the promise to repay the amount to the bondholder at the end of the specified period. This, in other words, may be called the most important feature of bond, return of the principal to the lender on a fixed date specified earlier.

Feature # 2. Call:

Bonds have an additional feature of ‘call’. This is a privilege to the issuing company to re-purchase bonds at a slightly higher price above the par value. For example, a bond of face value of $1,000 and maturity of 20 years yields an interest of $70 annually. After the first 5 years of issue, the market rate of interest on bonds falls considerably.

The ruling rate being 5% the company may choose to use the call feature and buy back the bond for $1,050. This is a little higher than the face value of $1,000. By calling the bonds, the company saves money. It may call back the bonds yielding interest of $70 and issue fresh bonds which will yield $50 per year.

and also, Put ability — It is a bond given right to the holder so as to force the issuer to repay the bond before the maturity date on the put dates; (Note: "Putable" refers to an implicit put option; "Puttable" means that it may be putted.

Feature # 3. Interest:

The rate of interest to be paid to bondholder and the time of payment is recorded in the bond as well as in the indenture, ‘interest rate’ is also called the ‘coupon rate’. Interest on bond may be made by cheque or coupon. When interest is paid to the bondholder by cheque the principal amount on the bond is usually registered to interest value.

The coupons are numbered and every coupon represents, the interest payment period. When the coupon becomes due, the bondholder presents the coupon to the authorized banker and receives interest. The coupons are usually bearer bonds and are negotiable when they become due and payable.