Make-Whole Call Provisions on the TI 83 Plus

In recent years, bond issuers have changed from the traditional call schedule to a “make-whole” type of call. Generally, this is good for investors as it makes it less likely that high interest bonds will be called. If it is called, then they are “made whole” because they are paid the present value of the remaining cash flows. In a traditional call, investors would receive only the face value and, perhaps, a small call premium. In most cases, investors will be better off with a make-whole call.

For issuing firms the make-whole call provision provides some financial flexibility. For example, it may be that the covenants (restrictions on the issuer) are somewhat onerous, and the issuer may wish to get out from under them, or there may be a change of control. The make-whole call allows refunding without a call premium being paid or waiting until the next call date specified in the bond’s indenture.

A make-whole call provision means that the bond can be called at any time (on short notice – generally 30 or so days), and that the issuer will pay the present value of the remaining cash flows to investors. Importantly, this will be different than the current price of the bond because the discount rate is different than the recent yield to maturity. Specifically, the discount rate that is used to determine the present value is spelled out in the indenture and will be equal to the rate on a Treasury security plus some spread that is also given in the indenture. The spread is fixed at issuance (usually 15 to 50 basis points, depending on credit rating and term to maturity), though the “Comparable Treasury Issue” can change. The Treasury security that is used will be selected by an independent investment banking firm at the time of the call.

In this tutorial, we will see how to calculate the price at which the bond would be called by using the NPV and PV functions of the TI 83 Plus financial calculator.

Example of a Bond with a Make-Whole Call Provision

In late 2010, PPG Industries issued a bond that matures on 15 November 2040. The bond pays interest semiannually with a coupon rate of 5.50% per year (on 15 May and 15 November). You can see the details of this issue here. The indenture states that “optional redemption” will be on a make-whole basis at a spread of 25 bps over the comparable Treasury.

On 28 October 2014 the bond traded at a price of 117.95 (\$1,179.50), though we will pretend that the trade took place on 15 November 2014 so that we do not need to worry about valuing the bond between coupon payment dates.

On 13 November 2014, a comparable Treasury bond (the 4.25%’s of 2040) was trading at 122.7969. We will again assume that this quote was from 15 November 2014. The yield on this security was 2.98%. Therefore, the yield that will be used to calculate the present value of the remaining payments is 2.98% + 25bps = 3.23%.

With these minor simplifications, we will now determine the call price of the PPG 5.5’s of 2040. To do so, we need to calculate the present value of the remaining cash flows at the appropriate discount rate. There are 51 remaining interest payments o\f $27.50 each, plus one payment of \$1,027.50 (return of principal + last interest payment). On the TI 83 Plus there are two ways to do this calculation. The image below shows the timeline for the cash flows:

Using the PV Function in the TVM Solver

Go to the TVM Solver by pressing APPS, choose Finance, and then TVM Solver. Since there are 52 payments remaining, enter 52 for N, 3.23/2 (1.615) for I%, 27.50 for PMT, and 1000 for FV. Remember that we are using semiannual compounding, so the interest rate must be divided by 2. Now scroll back to PV and then press ALPHA ENTER to get the answer. You should get \$1,397.28. Note that this is slightly different than I got in my Excel tutorial (\$1,396.54) because I rounded the interest rate for this one.

The image below shows what your TVM Solver screen should look like after solving the problem:

Using the TI 83 Plus NPV Function

You can also use the NPV function. If you believe the manual, you will have to first create a table of the cash flows (52 entries). However, there is a shortcut that I have discussed elsewhere. You can enter the cash flows directly into the function by specifying them within curly braces. In addition, we can specify how often each set of cash flows occurs in a second set of curly braces that follows the first. We will use that trick here to minimize the amount of data entry required.

Launch the TVM Solver by pressing APPS and then Finance. Choose the NPV function (7) from the list, and your screen will show:

NPV(

Recall that the arguments are:

NPV(Interest Rate, Initial Outlay, {Cash Flow 1, Cash Flow 2, …}, {Freq of CF 1, Freq of CF 2, …})

Because we only want the present value, we will set the initial outlay to 0. So, the formula is:

NPV(3.23/2, 0, {27.50, 1027.50}, {51, 1})

When you press ENTER, you will see that the answer is \$1,397.28, which is exactly the same that we got with the TVM Solver. The image below shows what your screen should look like when using the NPV function:

Note that whichever way you choose to do it, you get a call price of \$1,397.28, which is \$217.78 above the current price of the bond. Obviously, PPG is unlikely to call the bond under these circumstances. If you wish, you can download the spreadsheet that I created for my Excel tutorial so that you can more clearly see how this works. Just remember that the answer in the spreadsheet will be slightly different because I rounded the numbers for this tutorial. The spreadsheet is more accurate.