Trying to understand early call price calculation

I am looking at bonds which offer the issuer an early call option at the higher of par or "an amount calculated by reference to the yield"of a specified Gilt + 0.5%. I am not clear what the words in quotes mean.

Assume for present purposes that both the bonds and the Gilt have 3.5 years to run, the bond is a £100 unit with a nominal yield of 6%, and that the nominal Gilt yield is 3.75% with a current price of £115 and a GRY of 0.17%.

What is the amount at which the bonds could be redeemed now and how is that calculated ?

Comments

  • The way I understood it is that issue can redeem early at either par, ie 100, or the value of the bond if the yield were .17 +.5, whatever that is when calculate. Second option is much higher.
  • New one on me, can I ask which bond you are looking at?

    Silly question really but are you sure it isn't "call at par or extend the bond at new interest rate of specified Gilt + 0.5% (in this instance 3.75% +0.5%)? That's quite common.
  • VSIVSI
    edited March 2017
    If a bond does not have a "Call Feature" (i.e. it matures as a bullet payment at par on Maturity Date, w/ issuer having no prepayment ability at or above par price before then), the issuer has to pay a "Make-Whole Premium" to redeem the bonds.

    Typically, this MW premium entails: all future interest payments till maturity which is then discounted back at a certain rate (generally Gilt + 50bps) to get a NPV of future stream of cashflows that the investor would have been entitled to.

    Reason for this is so the investors have some optionality for future upside - if the credit of the issuer improves, it should be able to refinance at a lower rate; however, with the call protection (i.e. unable to call it) results in bonds trading up to reflect a better credit profile / lower yield requirement vs. @ issuance credit profile.

    Hope this is somewhat clear!
  • edited March 2017
    Laughton - The bond I am looking at is: Unite Group plc (UTG1) 6.125% Bonds 2020. It seems a not wholly unattractive yield for something as safe as can be and of a relatively short term, if there is no risk of an early call.

    I have Googled the terms and it seems that this not an uncommon call provision. The wording is odd though as it seems to jumble yield and price (as your comment recognises, it would be more logical to use a reference rate with uplift than a reference price plus a percentage uplift). Hence the question.

    prdepp - Is there some sort of formula which shows how this would work in practice ?

    VSI - I think I follow what you are saying, but this bond does have a call feature and what you say obviously provides no comfort at all if one has bought significantly above par. Is there a formula somewhere to see how this would work out in practice ?
  • VSIVSI
    edited March 2017
    Normally you do this calculation on Bloomberg which has a Make Whole feature.

    For this specific bond, it seems the optional "Redemption Price" is defined as the higher of: (i) Principal outstanding; or (ii) Principal X Price @ which Gross Redemption Yield on the bond = Gross Redemption Yield on 3.75% UK Gilt 2020 at the time of redemption.

    Currently the 3.75% UK Gilt 2020 is yielding about 0.18%. So if the company were to redeem its bonds today, you have to figure out the price for Unite Bond at which ITS yield will match the same as that for said Gilt. Based on my estimation, the Unite Redemption Price would be close to 119, so well above the current 109 7/8 being quoted in the market.

    At least this is my understanding - please do not hold me responsible for any inaccuracies! Caveat Emptor...
  • edited March 2017
    VCI - Thanks for the explanation. With your explanation of what to look for, I think I have managed to confirm your understanding and have found a way to do the calculation on Excel at:

    http://www.tvmcalcs.com/calculators/apps/make_whole_call_provision_in_excel

    I have not run the numbers on Excel, but at least I now know broadly what I am looking for. I am very new at this, and wondered if this is regarded as a decent return for what I believe to be a pretty secure investment: the company's assets are property, and the £90m bonds will obviously rank ahead of the shares (market cap £1.4bn) if something were to go wrong.

    AS a PS, I have now run the numbers on Excel (the spreadsheet can actually be downloaded) but can't get it to work (no surprise there !!). I seem to stumble when using the Yield function to compute the current yield. On the reference Treasury 2020 3.75% selling at 112.75, the yield shows as 0.0781%, whereas this should be a (still meagre) 0.178%. So, I seem to have stumbled at the first hurdle !
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