What is Call Protection?
How Does Call Protection Work?
Call protection is described in a callable bond's indenture. Callable corporate and municipal bonds usually have 10 years of call protection. For example, let's assume XYZ Company issues a 10%, 20-year bond in 2000. If the bond has 10 years of call protection, that means XYZ Company cannot call the bond until at least the year 2010. If interest rates fall to 5% during the first 10 years of the XYZ Company bond's life, call protection lets bondholders lock in above-market returns (i.e., 10% interest until the year 2010, rather than the prevailing 5%).
Why Does Call Protection Matter?
Call protection can be extremely beneficial for bondholders when interest rates are falling. Remember, there is strong incentive for issuers to call high-rate bonds and reissue lower-rate bonds.
It is important to note that call protection is not the same as refunding protection. MIT prohibits the issuer from redeeming the bonds with proceeds from lower-cost debt, but it does not prohibit the issuer from redeeming the bonds for other reasons.