Understanding hard calls and make-whole provisions
Consider a HY bond with a 6-year maturity, a 8% coupon, non-call for 3 years – except with a make-whole premium
How does the make-whole premium works? For example if the bond was issued 4 months ago, and I want as a firm to refinance it, would I have to pay: 100 + 8 = 108 to refinance the loan? Or 100 + 8*4/12? What if I want to refinance 11 months after issuance?
If it was a hard call without the "make-whole" exception, it implies I simply wouldn't be able to refinance? Or a hard call always implies a make-whole provision?
bump for visibility
Typically the first call price is set at half the coupon, so in your example this bond would be a 6NC3 with a first call price of 104. Now, let's say that the company wants to call this bond at the end of year 1. In such a case you, the holder, would get the present value of the sum of the coupons in year 2, year 3, and the principal at 104. The discount rate used to PV these cashflows is usually the government bond yield to the call date, so in this case, the 2-year bond. On a Bloomberg terminal, the "make-whole" price is calculated for you so you don't have to do this calculation.
Oooo okay, so if the government bond yield is 3%, then:
Make-whole price (if we assume 1st coupon already received) at end of year 1 is:
8/[1,03^(1)] + (104+8)/[1,03^(2)] = 116.7
The whole computation also depends on the first call price right? In this case, we can call the bond at the beggining of the year 4, right after paying the 3rd coupon?
also interested in knowing
You don't discount the principal. The payment is principal + MW.
That's not correct - it's misleading as to the amount of the make-whole premium and while certain docs (especially loans that import the make-whole concept, which is normally a bond concept) make this error, that is not a true statement on a standard bond doc. While it is true that the payment is "principal plus make-whole" in a standard bond doc, but the way the make-whole is actually calculated is exactly using the formula in the example (plus 50bps).
“Applicable Premium” means: (A)with respect to any Note, the greater of: (i)1% of the principal amount of such Note; and (ii)the excess (to the extent positive) of: (1)the present value at such redemption date of (i) the redemption price of such Note at January 31, 2026 (such redemption price (expressed in percentage of principal amount) being set forth in the table under Section 3.07(a) (excluding accrued and unpaid interest)), plus (ii) all required interest payments due on such Note to and including January 31, 2026 (excluding accrued but unpaid interest), computed upon the redemption date using a discount rate equal to the Treasury Rate at such redemption date (or, if greater than such Treasury Rate, zero) plus 50 basis points; over (2)the outstanding principal amount of such Note,Let's just make this concrete and take a generic large high-yield bond - let's use the most recent bond issued by ATUS. Here's the language:
As you can see (let's ignore the minimum 1% part here), the calc is (assuming this was an 8% bond (paying annually, even though standard convention is semiannual); first call price is 104, and T is 3%) that the make-whole premium is: (104/1.035^2)+(8/1.035^2)+(8/1.035) "minus" 100. But then you just add the 100 back to it.
So you absolutely *do* discount the principal in calculating the *amount* of the make-whole. If you didn't, the make-whole in this hypo would be ~7 points too high (104 vs. the 97 that is the result of the first term above). If you think about it, it would be bizarre without this - you'd get large positive make-wholes on bonds where the coupon is below treasuries. (Imagine T was 9.5% so you're discounting by 10 - if you don't "discount" the 104 term, you'd end up having a huge make-whole on a 8% bond in a 10% rate world - that's stupid, and not what bond docs say.)
Very simply point here is - just read the doc and do the math. You *do* discount the first call price from the first call date to today. You use that to calculate the premium, which gets added to the makewhole. So you're not "discounting" the principal directly - but you have to discount it (as the poster did, correctly) to calculate the amount of the makewhole. And just "subtracting par" and then "adding it back" doesn't make a huge difference. In any case, you can usually just do this in excel as follows... "= PRICE( pricing date, first call date, coupon rate on bond, T+50, first call price (usually 100 + coupon / 2), 2)" - try it with the example calc above and you'll see they match exactly (the manual calc vs. the "PRICE" function) so long as you change the last parameter in PRICE to 1 rather than 2.
Realistically this is done using the excel function PRICE() and input coupon, yield (treasury + 50 bps), call price at call date, maturity = first call date
Why +50bps? is it a convention?
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