5. Read the text. Explain the following word combinations. Summarize the text in 50 words.

• a call provision

• the call price

• the sinking fund

• covenants

• to retire a bond issue

• callable bonds

Call provisions

Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back. The call provision usually requires a waiting period between the time the bond is initially issued and the time when it can be called. The price bondholders are paid for the bond is usually set at the bond's par price or slightly higher (usually by one year's interest cost). For example, a 10% coupon rate $1000 bond may have a call price of $1100.

If interest rates fall, the price of the bond will rise. If rates fall enough, the price will rise above the call price, and the firm will call the bond. Because call provisions put a limit on the amount that bondholders can earn from the appreciation of a bond's price, investors do not like call provisions.

A second reason that issuers of bonds include call provisions is to make it possible for them to buy back their bonds according to the terms of the sinking fund. A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year. This provision is attractive to bondholders because it reduces the probability of default when the issue matures. Because a sinking fund provision makes the issue more attractive, the firm can reduce the bond's interest rate.

A third reason firms usually issue only callable bonds is that firms may have to retire a bond issue if the covenants of the issue restrict the firm from some activity that it feels is in the best interest of stockholders. Suppose that a firm needed to borrow additional funds to expand its storage facilities. If the firm's bonds carried a restriction against adding debt, the firm would have to retire its existing bonds before issuing new bonds or taking out a loan to build the new warehouse.

Finally, a firm may choose to call bonds if it wishes to alter its capital structure. A maturing firm with excess cash flow may wish to reduce its debt load if few attractive investment opportunities are available.

Because bondholders do not generally like call provisions, callable bonds must have a higher yield than comparable non callable bonds. Despite the higher cost, firms still typically issue callable bonds because of the flexibility this feature provides the firm.

5. Match the responses on the right with the questions on the left.

1.	So what exactly are bonds?	a.	Because of changes in interest rates. For example, no-one will pay the full price for a 6% bond if new bonds are paying 10%.
2.	And how do they work?	b.	Exactly. And the opposite, a bond whose market value is higher than its face value, is above par.
3.	So you have to keep them for a long time?	c.	I knew you'd finish by saying that!
4.	Why should that happen?	d.	No, not at all. Bonds are very liquid. They can be sold on the secondary market until they mature. But of course, the price might have changed.
5.	Oh, I see. Is that what they mean by below par?	e.	No, not unless it's a floating rate bond. The coupon, the amount of interest a bond pays, remains the same. But the yield will change.
6.	But the bond's interest rate doesn't change?	f.	No, those are short-term (three-month) instruments which the government sells to and buys from the commercial banks, to regulate the money supply.
7.	How's that?	g.	That's the name they use in Britain for long-term government bonds — gilts or gilt-edged securities. In the States they call them Treasury Bonds.
8.	And people talk about AAA and AAB bonds, and things like that	h.	They're securities issued by companies, governments and financial institutions when they need to borrow money.
9.	And what about gilts?	i.	Well, a bond's yield is its coupon payment expressed as a percentage of its price on the secondary market, so the yield changes if you buy or sell above or below par.
10.	Not Treasury Bills?	j.	Well, they usually pay a fixed rate of interest and are repaid after a fixed period, known as their maturity, for example five, seven, or ten years.
11.	And James Bond	k.	Yes. Bond-issuing companies are given an investment grade by private ratings companies such as Standard & Poors, according to their financial situation and performance.

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