Problem
There are numerous types of debt with many different names. Fundamentally, the common characteristics of debt include:
A. They are contracts that lay out future cash flows paid by the borrower to the lender.
B. They indicate the maturity of the debt-that is, when it must be paid back.
C. They indicate the interest rate the borrower will pay to the lender and the type of interest paid ("fixed" over time versus "adjustable").
D. They list any covenants-that is, agreements between the lender and borrower about limits on certain financial ratios that the borrower must maintain.
E. They list any included call provisions. A call provision permits the borrower to redeem or pay back the debt prior to maturity. Usually, a call provision includes a premium in which the borrower pays more than the maturity value.
Now, take a few moments to reflect and answer the following questions.
1) Why would issuers want callability?
2) Why would lenders demand a premium to include them?
3) How do call provisions influence the risk of the debt to borrowers? To lenders?