Which feature of a bond contract allows the issuer to redeem bonds under specified terms prior to maturity? Convertible provision Put provision Call provision Sinking fund provision Issuers can gradually reduce the outstanding balance of a bond issue by using a sinking fund account into which they deposit a specified amount of money each year. To operationalize the sinking fund provision of an indenture, issuers can (1) purchase a portion of the debt in the open market or (2) call the bonds if they contain a call provision. Under what circumstances would a firm be more likely to buy the required number of bonds in the open market as opposed to using one of the other procedures? When interest rates are higher than they were when the bonds were issued. When interest rates are lower than they were when the bonds were issued.

Bond Contract:

1. Call provision allows the issuer to redeem bonds under specified terms prior to maturity.

2. To operationalize the sinking fund provision of an indenture, issuers can (2) call the bonds if they contain a call provision.

3. A firm is more likely to buy the required number of bonds in the open market as opposed to using one of the other procedures "When interest rates are lower than they were when the bonds were issued."

Explanation:

a) Call provisions:  When a bond contains a provision that enables the issuer to buy the bond back from the bondholder at a pre-specified price prior to maturity, the bond is said to be callable.  Issuers use this provision to reduce their interest  if rates fall after a bond is issued.  This is because existing bonds can then be replaced with lower-yielding bonds.

A call provision is not to the advantage of the bondholder, hence, the bond will offer a higher yield than an otherwise identical bond with no call provision.   A call provision cannot be bought or sold separately from the bond, therefore, it is called an embedded option.

b) Sinking Fund: Bonds issued with a provision that requires the issuer to repurchase a fixed percentage of the outstanding bonds each year, regardless of the level of interest rates is said to be issued with a sinking fund provision.  This reduces the possibility of default, that is, when a bond issuer is unable to make promised payments in a timely manner.  A sinking fund reduces credit risk to bondholders and is offered with a lower yield than an otherwise identical bond with no sinking fund.

c) Bonds, generally, are debt securities issued by an entity to the public with a promise to repay the borrowed funds with fixed period interest.  They can be issued at par, a discount, or a premium.

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