5. Bonds with Contingency Provisions

f. describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender.

What is an embedded option? An embedded option is a provision in a bond indenture that gives the issuer and/or the bondholder an option to take some action against the other party.

What is a callable bond? A bond issue that permits the issuer to call or refund an issue prior to the stated maturity date is referred to as a callable bond.

What is a deferred call? Typically, call provisions have a deferment period; that is, the issuer may not call the bond for a number of years until a specified first call date is reached.

What are the three types of callable bond exercise styles? 1. American call: any time starting on the first call date 2. European call: once on the call date 3. Bermuda-style call: on predetermined dates following the call protection period

What is a putable bond? A put option grants the bondholder the right to sell the issue back to the issuer at a specified price (“put price”) on designated dates.

What is a convertible bond? A convertible bond is an issue that grants the bondholder the right to convert the bond for a specified number of shares of common stock.

What is the conversion price of a convertible bond? The conversion price is the price per share at which a convertible bond can be converted into common stock.

What is the conversion ratio of a convertible bond? The conversion ratio is the number of common shares each bond can be converted into.

What are warrants? Warrants are securities entitling the holder to buy a proportionate amount of stocks at some specified future date at a specified price. They are similar to call options.