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What is a Call-Protection Clause and Why It Matters for Investors
Definition & Meaning
A call-protection clause is a provision found in certain bond or callable-preferred-stock agreements. This clause prevents the issuer from redeeming or "calling" the security before a specified period, known as the cushion. During this cushion period, investors are protected from the risk of having their bonds called when interest rates decline, which could limit their potential returns. Typically, municipal and industrial bonds have a call protection period of ten years, while utility debts often have a shorter protection span of five years. A longer call protection period is generally more beneficial for investors.
Table of content
Legal Use & context
The call-protection clause is primarily used in the context of bond issuance and investment. It serves to safeguard bondholders against early redemption by the issuer, particularly in a declining interest rate environment. This clause is relevant in financial and securities law, where investors may utilize legal templates from US Legal Forms to draft or review bond agreements that include such clauses.
Key legal elements
Real-world examples
Here are a couple of examples of abatement:
Example 1: An investor purchases a municipal bond with a ten-year call protection clause. For the first ten years, the issuer cannot call the bond, allowing the investor to benefit from the fixed interest rate even if market rates fall.
Example 2: A callable-preferred stock includes a five-year call protection clause. After five years, the issuer has the right to call the stock, which may occur if interest rates drop significantly. (hypothetical example)
State-by-state differences
Examples of state differences (not exhaustive):
State
Call Protection Duration
Notes
California
10 years
Common for municipal bonds.
Texas
5 years
Standard for utility bonds.
New York
10 years
Often includes additional investor protections.
This is not a complete list. State laws vary and users should consult local rules for specific guidance.
Comparison with related terms
Term
Description
Callable Bond
A bond that can be redeemed by the issuer before its maturity date, typically after a specified call protection period.
Put Option
A provision allowing bondholders to sell the bond back to the issuer at a specified price before maturity.
Convertible Bond
A bond that can be converted into a predetermined number of the issuer's shares, providing potential equity upside.
Common misunderstandings
What to do if this term applies to you
If you are considering investing in bonds with a call-protection clause, review the bond's terms carefully. Ensure you understand the call protection period and how it may impact your investment returns. You can explore US Legal Forms for templates that can help you draft or review bond agreements. If you have specific questions or complex situations, consulting a financial advisor or legal professional is advisable.
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