Probability of call and likelihood of the call feature in a corporate bond

Abstract This paper suggests a new way of predicting the likelihood of a corporate bond being callable. We compute the probability that a bond, if callable, would actually be called within a certain period. We also hypothesize a positive relationship between this probability and the likelihood of the bond being issued with a call feature. Comparative static results yield the following empirical implications: the likelihood of a call feature should be an increasing function of coupon rate, corporate tax rate and leverage ratio, and a decreasing function of interest rate and firm risk (volatility). Tests with recently issued corporate bonds provide fairly strong support for the model’s predictions.

[1]  David C. Mauer,et al.  Optimal Bond Call Policies under Transactions Costs , 1993 .

[2]  Eduardo S. Schwartz,et al.  Savings bonds, retractable bonds and callable bonds , 1977 .

[3]  M. Narayanan,et al.  BOND REFUNDING IN EFFICIENT MARKETS: A DYNAMIC ANALYSIS WITH TAX EFFECTS , 1991 .

[4]  F. Black,et al.  VALUING CORPORATE SECURITIES: SOME EFFECTS OF BOND INDENTURE PROVISIONS , 1976 .

[5]  Amir Barnea,et al.  A RATIONALE FOR DEBT MATURITY STRUCTURE AND CALL PROVISIONS IN THE AGENCY THEORETIC FRAMEWORK , 1980 .

[6]  Richard J. Kish,et al.  Determinants of the call option on corporate bonds , 1992 .

[7]  Merton H. Miller,et al.  DEBT AND TAXES , 1977 .

[8]  D. Mauer,et al.  Corporate Call Policy for Nonconvertible Bonds , 2000 .

[9]  F. Longstaff,et al.  Calling Nonconvertible Debt and the Problem of Related Wealth Transfer Effect , 1994 .

[10]  Peter Mayall,et al.  Corporate Financial Management , 1974 .

[11]  J. Hull.  Options, Futures, and Other Derivatives , 1989 .

[12]  R. Bowman.  The Importance Of A Market-Value Measurement Of Debt In Assessing Leverage , 1980 .

[13]  H. Leland.,et al.  Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads , 1996, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[14]  H. Leland..  Corporate Debt Value, Bond Covenants, and Optimal Capital Structure , 1994, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[15]  J. Vu.  An empirical investigation of calls of non-convertible bonds , 1986 .

[16]  H. Leland..  Agency Costs, Risk Management, and Capital Structure , 1998 .

[17]  Jess B. Yawitz,et al.  THE EFFECT OF BOND REFUNDING ON SHAREHOLDER WEALTH , 1977 .

[18]  J. Harrison,et al.  Brownian motion and stochastic flow systems , 1986 .

[19]  J. Zechner,et al.  Dynamic Recapitalization Policies and the Role of Call Premia and Issue Discounts , 1989, Journal of Financial and Quantitative Analysis.

[20]  D. Mauer,et al.  Valuation of Callable Bonds Under Progressive Personal Taxes and Interest Rate Uncertainty , 1991 .

[21]  Edward Henry Robbins,et al.  Callable Bonds: A Risk-Reducing Signalling Mechanism , 1986 .

[22]  Wilbur G. Lewellen,et al.  Debt Management under Corporate and Personal Taxation , 1987 .

[23]  R. C. Merton,et al.  On the Pricing of Corporate Debt: The Risk Structure of Interest Rates , 1974, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.