Callable Features

Callable bonds

Many convertibles allow the issuer to call the bond before the maturity date. But of course if the convertible is “in the money” investors will convert rather than accept the cash redemption. This call can sometimes be subject to a trigger, such as parity needing to be 120% or 130% before the call is activated.

Hard Call – Most convertible bonds are issued with a period of call protection during which the issuer may not redeem (call) the bonds early. “Hard” call protection is the period during which the bonds cannot be called under any circumstances.

Soft Call – “Provisional” protection is when the bonds can be called subject to the share price being above a certain level. Call protection is important for investors as it guarantees the optionality of the convertible and whatever yield advantage it has over the underlying shares for a fixed period of time. The longer the call protection, the greater the benefit for investors.

Make-whole clauseA typical convertible has call protection in the early years of the security’s life. Some issues have built in the option to force conversion immediately if the stock has had a strong run. Issuers paid for this privilege with the “make-whole” payment, which requires them to compensate the holder for this early redemption. Make-whole payments have fallen into two categories: (1) premium or (2) forgone income (coupon).

A “premium” make-whole compensates the holder for the premium paid at issuance. This premium payment is stepped down over time, deducting dividends/coupons as they are paid. A “dividend/coupon” make-whole compensates the holder for the foregone future cash flows he would have received under a hard call scenario, generally three to five years. As in the case of a premium make-whole, the payment is reduced over time to reflect coupons received.

Use make-whole takeout matrix for soft call (TRW 3.5% 12/01/15)

Under Article 3 Redemption and Repurchases Section 3.01h,

With respect to any Notes that are exchanged following a notice of redemption, the Company will increase the Exchange Rate for the Notes so surrendered for exchange by a number of Additional Shares, if any, pursuant to Section 11.03.

Present value of remaining coupons (MU 4.25% 10/15/13)

Under Article 11 Redemption

(b) The redemption price at which the Notes are redeemable (the “Redemption Price”)shall be equal to (i) 100% of the principal of Notes to be redeemed, plus (ii) accrued and unpaid interest (including Additional Interest), if any, to, but excluding, the Redemption Date, plus (iii) the Make-Whole Premium; provided, however, that if the Redemption Date is after a Regular Record Date and prior to the Interest Payment Date to which it relates, then the accrued and unpaid interest, if any, to, but excluding, the Redemption Date, shall be paid on such Interest Payment Date to the holders of record of such Notes on the applicable Regular Record Date instead of the holders surrendering such Notes for redemption on the Redemption Date (and in this circumstance, the Make-Whole Premium shall be calculated based on the present values of the remaining scheduled payments of interest on such Notes, starting with the next Interest Payment Date for which interest has not been provided for herein). The Trustee shall have no duty to determine or calculate the Make-Whole Premium, which shall be determined by the Company in accordance with the provisions of this Indenture, and the Trustee shall not be under any responsibility to determine the correctness of any such determination and/or calculation and may conclusively rely on the correctness thereof.

The Make-whole amount is under Defined Terms,

Make-Whole Premium” means, with respect to each $1,000 in principal amount of Notes, a payment in Cash, shares of Common Stock or a combination of Cash and shares of Common Stock, equal to the present values of the remaining scheduled payments of interest on the Notes to be redeemed from the Redemption Date to October 15, 2013 (excluding interest accrued to, but excluding, such Redemption Date, which is otherwise paid pursuant to clause (ii) of the definition of Redemption Price), computed using a discount rate equal to 2.5%.