Make Whole Call

[beachfire]

I searched, but did not see this covered. I have done some on-line research and read prospectus language for a “Make Whole Call (MWC)” provision on a bond. Can someone help explain it in simple English. To use an example, if I bought a 7% coupon bond for 110.00 maturing in 2031 with a MWC provision and it got called a month after I bought it and the market price for the bond was 111.00 at the time it was called. Would I get 100, 110 or 111? In addition it seems there is some payment for the net present value of coupon payments over the remaining life of the bond, would I get that too?

Just trying to understand how these things work in reality. I realize that there can be variation of MWC terms between different bonds, just trying to get general grounding. Thanks for any thoughts.

 

[njhowie]

Would I get 100, 110 or 111? In addition it seems there is some payment for the net present value of coupon payments over the remaining life of the bond, would I get that too?

The greater of 100 or the NPV calculation.

As you are likely aware, many bonds can be called prior to maturity. The make whole call basically means that if they call early, they will pay the greater of the face value of the bond and the net present value of the remaining interest payments AND face value of the bond. The net present value is influenced by interest rates. The prospectus will indicate what treasury rate (and usually an additional amount/spread above it) is used for the NPV calculation. As a result, with rising interest rates, it's going to reduce the make whole amount you would receive should the issuer decide to call.

Now, notice I highlighted AND above. This is an important point. The face value of the bond is likewise discounted for the NPV calculation. The make whole call amount is the amount the creditor (investor) would receive if the bond were to go to maturity (100 plus all interest payments) discounted to the call date. This is why the amount you'd receive is the greater of face value and the NPV amount. It is quite possible that the NPV calculation results in a value lower than 100 depending on the coupon and treasury rate/spread used for the NPV calculation.