Important Differences Between Calls in Arrears and Calls in Advance

Calls in Arrears

Calls in arrears refer to the practice of calling for payment of a debt or obligation after it has become due. It is an action taken by the issuer of a bond or other financial instrument when the terms of the bond allow for the early redemption of the bond before its maturity date, but only after a certain period of time has passed. This allows the issuer to pay off the bond early, but at a higher cost than if they had redeemed it on the maturity date.

In the context of bond investing, calls in arrears can be disadvantageous to bondholders, as it may mean that they will receive their principal back earlier than expected and may not have the opportunity to earn as much interest as they would have if the bond had been held to maturity. Therefore, investors should be aware of the possibility of calls in arrears when considering bonds as an investment.

Examples of Calls in Arrears

Here are some examples of how calls in arrears can be used:

• A bond issuer may call in arrears a bond issue if interest rates have dropped significantly since the bond was issued. By redeeming the bond early at a higher cost, the issuer can refinance the debt at a lower interest rate, which can save them money in the long run.
• A company may call in arrears a bond issue in order to raise cash to fund a new project or to reduce overall debt.
• A bond issuer may call in arrears a bond issue if their credit rating has improved since the bond was issued, allowing them to issue new bonds at a lower interest rate.
• A bond issuer may call in arrears a bond issue as part of a buyback program, which can be used to reduce the number of outstanding bonds and increase the value of remaining bonds.

Types of Calls in Arrears

There are a few different types of calls in arrears that are used in the bond market:

1. Soft call: A soft call is a type of call in arrears that allows the issuer to redeem a bond before its maturity date, but only after a certain period of time has passed and at a slightly higher price than the face value of the bond. This type of call is less disadvantageous to bondholders as it allows them to earn a higher return than they would have if the bond had been held to maturity.
2. Hard call: A hard call is a type of call in arrears that allows the issuer to redeem a bond before its maturity date, but only after a certain period of time has passed and at a much higher price than the face value of the bond. This type of call can be disadvantageous to bondholders as it may mean that they will receive their principal back earlier than expected and may not have the opportunity to earn as much interest as they would have if the bond had been held to maturity.
3. Defeasance call: A defeasance call is a type of call in arrears in which the issuer of a bond sets aside funds to repay the bondholder the principal and interest that would have been paid if the bond had been held to maturity. This type of call can be beneficial to bondholders as it allows them to receive their principal and interest even if the bond is called early.
4. Sinking Fund call: A sinking fund call is a type of call in arrears in which the issuer of a bond sets aside funds to redeem a specific number of bonds annually, usually at face value or a slight premium. The issuer must redeem a certain number of bonds per year, usually at face value or a slight premium. This type of call is less disadvantageous to bondholders as it allows them to earn a higher return than they would have if the bond

Entries regarding Calls in Arrears

When a bond is issued with a call in arrears feature, the issuer will typically make certain entries in their accounting records in order to reflect the bond’s outstanding balance and the status of the call feature. Here are a few examples of entries that may be made:

• The bond will be initially recorded as a liability on the issuer’s balance sheet at its face value.
• When the bond is called in arrears, the issuer will typically make a journal entry to debit cash and credit the bond liability account for the amount paid to redeem the bond.
• If the bond is called in arrears at a premium, an additional journal entry may be made to debit the bond premium account and credit the bond liability account for the premium paid.
• If the bond is called in arrears and the issuer uses a sinking fund or defeasance to repay bondholder, the issuer will typically make a journal entry to debit the sinking fund or defeasance account and credit the bond liability account for the amount paid.
• If the bond is called in arrears and the issuer uses a sinking fund or defeasance to repay bondholder, the issuer will typically make a journal entry to debit the sinking fund or defeasance account and credit the bond liability account for the amount paid.

Calls in Advance

Calls in advance are a feature of some bond issues that allow the issuer to redeem the bond before its maturity date, but only after a certain period of time has passed and at a lower price than the face value of the bond. This type of call is less disadvantageous to bondholders as it allows them to earn a higher return than they would have if the bond had been held to maturity.

For example, a bond with a face value of $1000 and a maturity date of 10 years may have a call in advance feature that allows the issuer to redeem the bond after 5 years at a price of $950. This means that if the bond is called in advance, the bondholder will receive $950 instead of the full $1000 face value, but will have received the payment earlier than expected.

Types of Calls in Advance

There are a few different types of calls in advance that are used in the bond market:

1. Soft call: A soft call is a type of call in advance that allows the issuer to redeem a bond before its maturity date, but only after a certain period of time has passed and at a slightly lower price than the face value of the bond. This type of call is less disadvantageous to bondholders as it allows them to earn a higher return than they would have if the bond had been held to maturity.
2. Hard call: A hard call is a type of call in advance that allows the issuer to redeem a bond before its maturity date, but only after a certain period of time has passed and at a much lower price than the face value of the bond. This type of call can be disadvantageous to bondholders as it may mean that they will receive their principal back earlier than expected and may not have the opportunity to earn as much interest as they would have if the bond had been held to maturity.
3. Defeasance call: A defeasance call is a type of call in advance in which the issuer of a bond sets aside funds to repay the bondholder the principal and interest that would have been paid if the bond had been held to maturity. This type of call can be beneficial to bondholders as it allows them to receive their principal and interest even if the bond is called earlier.
4. Sinking Fund call: A sinking fund call is a type of call in advance in which the issuer of a bond sets aside funds to redeem a specific number of bonds annually, usually at face value or a slight discount. The issuer must redeem a certain number of bonds per year, usually at face value or a slight discount. This type of call is less disadvantageous to bondholders as it allows them to earn a higher return than they would have if the bond had been held to maturity.

Entries regarding Calls in Advance

When a bond is issued with a call in advance feature, the issuer will typically make certain entries in their accounting records in order to reflect the bond’s outstanding balance and the status of the call feature. Here are a few examples of entries that may be made:

• The bond will be initially recorded as a liability on the issuer’s balance sheet at its face value.
• When the bond is called in advance, the issuer will typically make a journal entry to debit cash and credit the bond liability account for the amount paid to redeem the bond.
• If the bond is called in advance at a premium, an additional journal entry may be made to debit the bond premium account and credit the bond liability account for the premium paid.
• If the bond is called in advance, the issuer will typically make a journal entry to debit the sinking fund or defeasance account and credit the bond liability account for the amount paid.
• If the bond is called in advance and the issuer uses a sinking fund or defeasance to repay bondholder, the issuer will typically make a journal entry to debit the sinking fund or defeasance account and credit the bond liability account for the amount paid.

Comparison Between Calls in Arrears and Calls in Advance

Here is a table that illustrates the main differences between calls in arrears and calls in advance:

Important Differences Between Calls in Arrears and Calls in Advance

Here are some of the important differences between calls in arrears and calls in advance:

1. Redemption before maturity date: Both calls in arrears and calls in advance allow the issuer to redeem the bond before its maturity date, but the terms of each type of call are different.
2. Redemption price: Calls in arrears typically require the issuer to redeem the bond at or above its face value, while calls in advance allow the issuer to redeem the bond at a lower price than its face value.
3. Redemption date: Calls in arrears do not specify a redemption date, while calls in advance typically have a specified redemption date.
4. Redemption notice: Calls in arrears do not require the issuer to give notice of redemption, while calls in advance typically require the issuer to give notice of redemption.
5. Impact on bondholders return: Calls in arrears can be disadvantageous to bondholders as they may receive their principal back earlier than expected and may not have the opportunity to earn as much interest as they would have if the bond had been held to maturity. On the other hand, calls in advance can be less disadvantageous to bondholders as they may allow them to earn a higher return than they would have if the bond had been held to maturity.
6. Sinking fund or Defeasance: Calls in advance may have the option of using a sinking fund or defeasance to repay the bondholders. This is an important difference between calls in arrears, where this option is not available.

Conclusion Between Calls in Arrears and Calls in Advance

In conclusion, calls in arrears and calls in advance are two types of bond call features that allow the issuer to redeem the bond before its maturity date. The main differences between the two types of calls are the redemption price, redemption date, redemption notice, and the impact on bondholders’ return. Calls in arrears typically require the issuer to redeem the bond at or above its face value, while calls in advance allow the issuer to redeem the bond at a lower price than its face value. Additionally, calls in arrears do not specify a redemption date or require a redemption notice, while calls in advance typically have a specified redemption date and require a redemption notice. Furthermore, calls in arrears can be disadvantageous to bondholders as they may receive their principal back earlier than expected, while calls in advance can be less disadvantageous to bondholders as they may allow them to earn a higher return than they would have if the bond had been held to maturity. It’s important for investors to understand the call features of the bonds they hold, as it can affect their return on investment.