Hard Call Protection
What Is Hard Call Protection?
Hard call protection, or absolute call protection, is a provision in a callable bond by which the issuer can't exercise the call and recover the bond before the predefined date, typically three to a long time from the date of issuance.
Seeing Hard Call Protection
Investors who purchase bonds are paid interest (coupon rate) however long the bond's life would last. At the point when the bond matures, bondholders are repaid the principal value equivalent to the face value of the bond. Interest rates and bond prices have an inverse relationship — when the bond price declines, then yields rise, and vice versa. While bondholders like to invest in bonds with higher rates, as this converts into high interest income payments, issuers would prefer to sell bonds with lower rates to reduce their cost of borrowing.
In this manner, when interest rates decline, issuers will retire the existing bonds before they mature and refinance the debt at the lower interest reflected in the economy. Bonds that are repaid prior to maturity stop paying interest, constraining investors to track down interest income in another investment, as a rule at a lower interest rate (reinvestment risk). To safeguard callable bondholders from having their bonds repaid too early, most trust indentures incorporate a hard call protection.
A hard call protection is the period of time during which an issuer can't "call" its bonds. Callable corporate and municipal bonds ordinarily have a decade of call protection, while protection on utility debt is in many cases limited to five years. For instance, consider a bond that is issued with 15 years to maturity and a five-year call protection. This means that for the initial five years of the bond's life, no matter what the movement of interest rates, the bond issuer can't reclaim the bond by repaying the bond's principal balance. The hard call protection fills in as a sweetener as it guarantees investors will receive the stated return for a long time before the bond is "free" to be called.
Since the investor is facing the challenge of the bond being called prior to maturity, brokers will generally give yield-to-hard call as well as yield-to-maturity figures when a callable bond is being purchased. An investor ought to base their choices on the lower of these two yields, which is generally the yield to the hard call date.
After the hard call protection period lapses, the bond might keep on being partially protected by soft call protection. This feature requires certain conditions to exist before the bond can be called. Soft call protection is generally a premium to par that the issuer must pay to call in the bonds before maturity. For instance, the issuer might be required to repay investors a percentage over the full face value (say 105%) of the bond on the first call date. A soft call provision may likewise indicate that the issuer can't call a bond that is trading over its issue price. On account of convertible callable bonds, a soft call protection would keep the issuer from calling the bond until the price of the underlying stock rose to a certain percentage over the conversion price.
Callable bonds pay a higher return in view of the risk that the issuer will recover them before maturity. A retail note is an illustration of a type of bond that regularly incorporates hard call protection.
Highlights
- Hard call protection fills in as a sweetener as it guarantees investors will receive the stated return for protected period before the bond is "free" to be called.
- Hard call protection, or absolute call protection, is a provision in a callable bond by which the issuer can't exercise the call and recover the bond before the predefined date, normally three to a long time from the date of issuance.
- Callable bonds with a hard call protection ought to be valued by utilizing the yield-to-call method.
