Posted in Finance, Accounting and Economics Terms, Total Reads: 468
Definition: Call Protection
It is a time period during which the Bond/Security issuer is prohibited from calling or buying back the bond/Security. It is a Callable Bond’s Indenture. Usually callable corporate and municipal bonds have 10 year protection period while utility debt has 5 years of protection.
Company ABC issues a corporate bond in the year 2000: 9% interest rate and 20 year duration. Suppose the bond has a protection period of 10 years. The protection period ensures that the company cannot call back the bond until 2010.Hence the bondholders are protected from the fall in interest rates, i.e. they can lock in the above market returns until 2010. (If the market rates fall to 5% in that period, the bondholder is protected from that as he gets returns of 9% until 2010)
Importance of the Call protection
When interest rates are falling, the protection acts as a shield for the bondholders against certain practices by issuers like: calling back the high interest rate bonds and reissuing the lower rate bonds. And this holds special importance because nearly always calls happen during periods of reduced interest. (Empirical evidence to support it are available)
Also they are able to lock in the above market returns for a certain period.