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On the Call Provision in Corporate Zero-Coupon Bonds

Published online by Cambridge University Press:  06 April 2009

M. P. Narayanan  and
Suk-Pil Lim
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Abstract

A majority of corporate zero-coupon bonds includes a call provision, giving the firm the right to call the bond at par value. In this paper, we investigate whether or not it is optimal for the firm to call such a bond for refunding purposes, taking into consideration the effect of corporate taxes. We find that it is not optimal to refund the bond as long as the corporate tax rate is less than 50 percent. We find that a significantly higher proportion of callable zero-coupon bonds, compared to noncallables, has restrictive financing covenants, suggesting that the call feature is included to provide flexibility at a low cost for future recapitalizations as the firm's investment opportunities change.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 24 , Issue 1 , March 1989 , pp. 91 - 103
Copyright
Copyright © School of Business Administration, University of Washington 1989

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