IDEAS home Printed from https://ideas.repec.org/a/taf/apfiec/v23y2013i6p461-473.html
   My bibliography  Save this article

Setting the optimal make-whole call premium

Author

Listed:
  • Eric A. Powers
  • Sudipto Sarkar

Abstract

With a make-whole call, the call price is calculated as the maximum of the par value and the present value of the bond's remaining payments discounted at the prevailing risk-free rate plus a pre-specified spread known as the make-whole premium. The commonly accepted thumb rule in the investment banking community is to set the make-whole premium at 15% of the at-issue credit spread. Using a standard structural model, we calculate the optimal make-whole call premium, i.e. the make-whole premium that maximizes the ex-ante firm value subject to managers following a second-best call policy that maximizes the ex-post equity value. For reasonable parameterizations, optimal make-whole premiums are relatively close to 15% of the model-generated credit spread. Thus, the 15% thumb rule provides surprisingly good guidance for setting make-whole call premiums.

Suggested Citation

  • Eric A. Powers & Sudipto Sarkar, 2013. "Setting the optimal make-whole call premium," Applied Financial Economics, Taylor & Francis Journals, vol. 23(6), pages 461-473, March.
  • Handle: RePEc:taf:apfiec:v:23:y:2013:i:6:p:461-473
    DOI: 10.1080/09603107.2012.727972
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1080/09603107.2012.727972
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:apfiec:v:23:y:2013:i:6:p:461-473. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Chris Longhurst). General contact details of provider: http://www.tandfonline.com/RAFE20 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.