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Principles of finance a la shmoop how bonds are called or put...[Person picks up suitcase and replaces with new suitcase]

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Want to win the lottery without dropping the dough on like a zillion

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tickets buy a call provision you know most call provisions have a lottery

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provision... okay so this is not about going

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to 7-eleven and paying 2 bucks to the state's tax collection system because [Man carrying bags full of lottery tickets]

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like nobody ever wins those things do they rather a lottery in this sense

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refers to random numbers being assigned to individual series of bonds which make

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those bonds callable by the issuer at some point between when the bonds were [Money transfers from phone to bonds]

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issued and when the cash is collected by the company and when the bonds are fully

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paid off the big idea here is that calling a bond means that the original

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issuer is buying it back like hello bond 8675 309 I'm calling you I want you [Man calling for bond back]

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back please come back all right that is they return the cash to the

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investor who originally bought the bond plus interest and usually a small

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premium paid above the par value of the bond to reward the investor for of a

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hassle and you know that the bond then is considered paid off and done okay so [Bond stamped paid]

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let's say 20% of the outstanding bonds of whatever.com can be called after

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three years and then another 20% can be called after six years and so on until

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the whole thing's retired well the company had a banner year finding itself [Fireworks in the sky]

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with a ton of cash on its books at the end and having already acquired all of

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the corporate jets it wanted well the company decided to spend its remaining

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cash available by calling its outstanding bonds back home to the [Alien spacecraft picking up people from the city]

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mothership all right so what's that process like calling back your bonds

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well if the company wants to call them they spin the wheel of fortune and

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called lucky winners and losers remember there's lottery tickets or lottery [Person calling on a mobile]

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numbers associated with each bond paying each chosen bondholders something like a

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hundred and three cents on the dollar like a three percent premium here

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whatever it said in the paperwork when the bond was originally issued that the

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call premium would be should the bonds be called early well they do that they

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pay a thousand thirty bucks and retire the debt okay [Person hands over a check]

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if bond rates are high today and you're a bond fund portfolio manager well

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you're gonna want some protection, like if you buy someone's bonds which yield

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say 8% today but then what if the bonds are callable next month at par, or a

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hundred cents on the dollar and you're paying a hundred three cents on the

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dollar to buy those bonds that supposedly will be yielding eight

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percent forever and ever but then they get called in a month or a year or less [Person picks up telephone]

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than that well then you have what's called call risk so imagine a scenario

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where you've just paid a thousand thirty dollars for $1,000 par bond that in

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theory pays you 80 dollars a year in interest for the next ten years and you

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feel good about its risk default meaning that you trust that the bonds will you [Man giving presentation on call risk]

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know fully pay off fully down line but then since the bond has no call [Telephone rings]

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protection and interest rates suddenly plummet and the company can refinance

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the bonds elsewhere cheaper well, just one month later before even having paid

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semiannual interest the bonds you just paid a thousand thirty for each are

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called and well legally and you're kind of screwed you must surrender them for a [Person calling on a mobile]

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thousand dollars each you just lost three percent in a month nice job! To

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avoid such a calamity you'll want call protection like the

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company issuer of the bond agrees that it won't call these bonds for at least

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four years so time can pass and you can collect at least some interest along the

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way and if they do get called well then the company will pay a hundred three [Sticky note lands on 1 dollar bill]

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cents on the dollar or a hundred ten cents on the dollar or hundred twenty cents

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on the dollar to buy them back or something like that

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it's called protection so you don't end up losing money on your bonds and note [Money on fire]

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that if the company issuing ever wants to buy them back even if there's no call

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provision it can it's called tendering yeah the company tenderly gently asks if

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people would kindly like to sell it back their used debt they tenderly do this [Man with company briefcase for a head waving]

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that's why it's called tendering the company just tiptoes into the open

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market and tenderly offers whatever the market price is for those bonds like a

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hundred two dollars and seventy three cents or something like that like at a

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2.7% premium and if there are any suckers out there who want

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to sell the company there are perfectly nice eight percent coupon bonds for

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ninety six cents on the dollar well then fine it'll go ahead and buy them back

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thank you very much wow this sounds apocalyptic but most bond investors are [Apocalyptic city up in smoke]

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a relatively dismal dark crowd to start with so the nomenclature fits; bond

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buyers just want to get paid back their interest and their principle and then go

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home and pray an errant airplane does not hit their house. Fittingly most bonds [Airplane in the sky, plummets and explodes]

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carry a yield to worst tag instead of a yield to call that is at worst like if

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my bond is called in the first tranche of potential lottery calls what will be

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the lowest or worst yield I'll get from this point forward on my investment

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Here's another twister when bonds are called

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early they usually carry that premium we mentioned specifically if a bond is

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callable at 1:02 any time well what does that mean well bonds trade in

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denominations of $1,000 right so what is 102 here right we said it's 2% premium

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so that would be the bond is callable for a thousand 20 let's say we've paid a

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thousand dollars for a bond yielding 8% and we hold it exactly 4 years

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collecting 80 dollars a year in interest each year and after 3.8 years we get a

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nasty little email saying thank you very much for your investment that we paid [E-mail from investment to bond buyer]

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you 8% a year in rent for money now we're gonna buy back that bond after 4

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years not letting it go to its full decade long duration sorry pal and for

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the privilege of buying it back we'll pay you a thousand $20 or a 2% call

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premium to retire those now very expensive-looking 8% bonds when we know

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we could refinance with someone else and rent money today at only 5%

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So, if we went back to the beginning of our investment well the yield to worst was [A stack of 100 dollar bills]

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in fact 80 plus 80 plus 80 plus 80 plus 20 plus a thousand or 1340 returned over

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4 years that's cumulative total the yield ended up being a bit more than 8%

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but you can imagine situations where the nominal rate was a very high relative to [Nominal rates value increase on a graph]

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market conditions number and investors paid 1,200 bucks for a bond callable

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four years later at a thousand twenty well they could have ended up tying up

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their money for four years renting it to other people and actually losing money

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it would be like renting your apartment not cashing the check for four years and [Apartment 4 rent sign on a block of apartments]

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then realizing that all the checks that you would have cashed bounced yeah that

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would not be good all right well we just outlined what a call provision looks

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like the right for the company to buy back the bond or call it home to the

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mother ship so then what on earth is a put well is

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it the right of a company to force you to buy a bond...No, but that would make for [Man with company briefcase for head holding a baseball bat]

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a really great reality TV show the put option is given to the holder of the

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bond the holder has the right to put the bond back to the company usually at a [Bond holder puts bond to the company]

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preset price and usually at a discount to the principle price right so it's

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kind of the inverse of a call so the bonds of whatever dot-com might have had

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to have had this extra feature in order for cautious buyers of their bonds to be [Person slowly picks up a bond]

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enticed to buy them why is a put appealing to cautious buyers, well

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because the buyers then legally have the right to get their money back after what

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is essentially a small bond restocking fee...A put provision might have said

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something like puttable anytime after four years at 96 so that means [bond yields transfer to company]

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that owners of the bond could force the company after four years to buy back

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their bond for ninety six cents on the dollar or nine hundred sixty bucks for

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that thousand dollar par value bond well why would a company offer such a great

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deal to investors in its bonds well it would offer it if it had to and

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pretty much only if it had to to entice them to buy that is in order to get the [Lots of people walking fast]

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deal done to attract enough buyers to actually get the bond offering to you

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know happen well they'd have to offer a put the belief in this case by the

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buyers is that the company will still be solvent or at least solvent enough so

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that in four years if everyone who owns these bonds wants to sell them back to

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the company at ninety six cents on the dollar nine hundred sixty bucks four

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thousand dollar principal bond that the company will have the dough or access to [Stacks of money in a vault]

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it via other debt it would issue in place you know to buy back those bonds

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that the investors in them have put back to the mothership....Here's

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hoping but hey well even if the odds aren't a hundred percent that you make a

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nice return on your bond investment well they're a whole lot better than the

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upcoming mega zillion Powerball ...[Road advert for the powerball]

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