What you need to know about the risks of fixed income investing. Make-whole calls MWC first appeared in the bond markets in the mid s and have become commonplace ever since. In fact, MWCs have become more commonplace in corporate bonds than their counterpart the traditional par call. Although this type of call option is infrequently exercised by the issuer, it may provide significant advantages to the bondholder, as well as to the issuer.
At the most basic level a MWC, when exercised by the issuer, provides an investor with a redemption price that is the greater of the following: MWCs are quoted in a spread to a predetermined Treasury security with a similar maturity; for example a year corporate bond would likely be matched to a year Treasury.
This differs from a traditional call option that has its call price either fixed or predetermined according to a call schedule. Whereas a traditional call can only occur after a specified period of time, it should be noted that a MWC can be exercised at any time.
Additionally, as the spread between the MWC bond and its benchmark Treasury narrows, the MWC price can continue to rise without a ceiling. Bonds that have a traditional call effectively have a price limit, or ceiling, as investors will be unlikely to purchase a bond for more than its call price once the call date draws near. In this example, we will use a three- year Treasury note as a reference security.
This would equate to a yield that is equal to a bp spread over the three-year Treasury note, which yields 0.
With a Make-whole call option, the call price is based on the Treasury yield at the time the call occurs, and, therefore, cannot be predicted.
Keep in mind, the call price is the greater of par or the price calculated using the make-whole-call premium. There are risks involved with this strategy including, but not limited to, changes in interest rates, liquidity, credit quality, volatility and duration.
Past performance is no assurance of future results. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Make-Whole Calls What you need to know about the risks of fixed income investing.
The call price will change as Treasury yield change. As the spread narrows the price will increase. Conversely, as the spread widens the price will decrease.
The call price will never be below par.More...