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HOW CHANGES IN BOND CALL FEATURES AFFECT COUPON RATES

HOW CHANGES IN BOND CALL FEATURES AFFECT COUPON RATES In April 1998, Level 3, a telecommunications company, sold $2 billion of 9.19%, ten‐year bonds to finance the building of a fiber‐optic network. Like most below‐investment‐grade issues, as well as many investment‐grade issues, the Level 3 issue contained an embedded call option that gave the company the right to repurchase the bonds after five years at par value plus the (semi‐annual) coupon rate, with the call price declining to par two years before maturity. Because issuers must pay for the call provision in the form of a higher coupon rate, the choice of whether or not to include a call option can be a difficult one. And, once management decides to include a call option, it must then decide how to structure the call. The most important call structure decisions are how long to make the call protection period and how to set the call price—both of which can have a significant impact upon the coupon yields required to attract investors. Using a well‐known option pricing model, the authors of this article summarize their recent research on how variations in bond call features can be expected to affect par coupon yields of new issues under different market circumstances—circumstances that include market conditions relevant to option valuation such as the shape of the term structure and the volatility of interest rates. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

HOW CHANGES IN BOND CALL FEATURES AFFECT COUPON RATES

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References (2)

Publisher
Wiley
Copyright
Copyright © 1999 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
DOI
10.1111/j.1745-6622.1999.tb00664.x
Publisher site
See Article on Publisher Site

Abstract

In April 1998, Level 3, a telecommunications company, sold $2 billion of 9.19%, ten‐year bonds to finance the building of a fiber‐optic network. Like most below‐investment‐grade issues, as well as many investment‐grade issues, the Level 3 issue contained an embedded call option that gave the company the right to repurchase the bonds after five years at par value plus the (semi‐annual) coupon rate, with the call price declining to par two years before maturity. Because issuers must pay for the call provision in the form of a higher coupon rate, the choice of whether or not to include a call option can be a difficult one. And, once management decides to include a call option, it must then decide how to structure the call. The most important call structure decisions are how long to make the call protection period and how to set the call price—both of which can have a significant impact upon the coupon yields required to attract investors. Using a well‐known option pricing model, the authors of this article summarize their recent research on how variations in bond call features can be expected to affect par coupon yields of new issues under different market circumstances—circumstances that include market conditions relevant to option valuation such as the shape of the term structure and the volatility of interest rates.

Journal

Journal of Applied Corporate Finance – Wiley

Published: Mar 1, 1999

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