Sometimes, after a party has issued a bond, it may wish to "call" the bond back. When this happens, the bond issuer is actually retiring all or part of the bond before the bond's maturity. When he does this, he agrees to pay a specific price to the bond holders, as stated when the bond is issued. However, if a deferred call provision is in effect, the issuer cannot call in the bond until a certain date.
Advantage: Guaranteed Receipts
One of the main advantages of a deferred call provision is that the investor will have a short period of time -- usually several years -- during which he will be able to plan on receiving receipts form the company. If a bond lacks this protection, then he may have the bond purchased out from him at any moment. This is excellent for any investor who wishes to receive payments on a bond, but not keep it to maturity.
In addition to providing the bondholder with a few years of predictable payments, deferring the call of a bond for several years also allows a company to plan financially. Because it does not have the option of calling the bond in, the company must make appropriate plans to pay the bond back until it has the option of buying it back. This means that its bond payments will be predictable for the near term.
Disadvantage: Ties Company's Hands
Perhaps the main downside for the company of a deferred call provision is that the company will not have the option of bringing the bond in early, thereby forcing it to commit to regular payments on the bond for several years, whether it has the cash to pay it all back at once or not. The company is effectively tying its own hands for the investor's sake with such a provision.
Disadvantage: Lower Interest Rates
One of the disadvantages, at least in the eyes of investors, is that bonds with a deferred call provision generally carry slightly lower interest rates than bonds with no call protection at all. This is the trade off for the bond investor receiving greater stability for his investment, as he receives less money in the form of interest payments on the bond.
- "Investing for Dummies"; Eric Tyson; 2009