What it means
When a company issues a bond, it often wants the option to repay early if its circumstances change, for example when it is selling a division or refinancing. A traditional call option sets a fixed call price in advance, which can leave investors short-changed if rates have fallen.
A make-whole call instead calculates the price at the time of the call, so investors are compensated for the income they give up. The calculation takes every remaining payment on the bond, meaning the coupons (the regular interest payments) and the final principal, and discounts them to today's value.
The discount rate is usually a benchmark government yield for the same remaining life plus a small fixed spread, such as 0.25% to 0.50%. Because that rate is low relative to the bond's own coupon, the resulting price is normally above par (the face value).
For the issuer, the call is a way to keep flexibility without paying a high up-front premium for it. Investors usually accept the feature because it protects them from being called away cheaply, and it is common in investment grade bonds.
The cost to the issuer tends to be high, which is why make-whole calls are used in practice only when there is a strong reason to repay. The price moves with market yields.
When government yields fall, the present value of the remaining payments rises and so does the make-whole price. This makes the call least attractive to the issuer exactly when refinancing at lower rates would otherwise look tempting.
Many make-whole bonds also include a normal call at par during the last few months or years of life. Readers should check the offering document, because the call schedule, the benchmark and the spread all vary from one bond to another.
In practice
Real-world examples.
Example
A manufacturing group agrees to sell a subsidiary and wants to use the proceeds to retire $300,000,000 of outstanding bonds. Because the bonds carry a make-whole call, it pays the calculated present value price rather than par, and bondholders receive full compensation for lost coupons.
Example
An investor holds a utility bond bought at a small premium and worries about early redemption. The make-whole feature reassures her, because if the bond is called she will receive roughly the value of all future payments, not a fixed price below what the bond is worth.
Example
A treasury team at a retailer compares refinancing costs. After running the make-whole formula it finds the call price is so far above par that waiting for a cheaper call window makes more sense.
Formula
Calculation
Make-whole price = Present value of remaining coupons and principal, discounted at (benchmark yield + spread)
Take a $1,000,000 bond with a 5% annual coupon and two years left to maturity. Assume the benchmark yield plus the spread gives a discount rate of 4%. The coupon is $1,000,000 x 0.05 = $50,000 a year, and the final payment is $1,000,000 + $50,000 = $1,050,000.
Present value of year 1 = $50,000 / 1.04 = $48,076.92. Present value of year 2 = $1,050,000 / 1.0816 = $970,784.02. The make-whole price is $48,076.92 + $970,784.02 = $1,018,860.94, so the issuer pays about $18,861 more than par to retire the bond early.Case study
Seen in the real world.
Brightwater Logistics is an illustrative, fictional freight company with a $50,000,000 bond carrying a 6% coupon and four years to maturity. When government yields fell sharply, the finance director wondered whether to refinance, and asked the bank to calculate the make-whole price.
The bank discounted the remaining coupons and principal at the benchmark yield plus 0.30%, and the answer was well above par. The extra cost wiped out most of the interest saving from issuing new debt at a lower rate.
Brightwater decided to leave the bond outstanding, and in this illustrative story the lesson was simple: a make-whole call protects investors so well that it is rarely the cheapest route to early repayment.
Watch out
Common mistakes.
- Assuming a make-whole call is repaid at par, when the price is usually above par and moves with market yields.
- Thinking the issuer can use it as a cheap way to refinance when rates fall, when falling rates increase the make-whole price.
- Ignoring the spread in the formula, which is set in the bond documents and changes the final price.
Questions
People also ask.
Why do issuers include a make-whole call?
It gives flexibility to repay early, for example after an asset sale, without the large fixed call premium that investors would otherwise demand.
Is a make-whole call good for investors?
Generally yes, because it compensates them for lost interest and means they are not called away at a price that leaves them worse off.
How is it different from an ordinary call?
An ordinary call has a fixed price or schedule set in advance, while the make-whole price is calculated at the time of the call from market yields.
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