There are numerous types of debt with many different names. Fundamentally, the common characteristics of debt include:
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There are numerous types of debt with many different names. Fundamentally, the common characteristics of debt include:
- They are contracts that lay out future cash flows paid by the borrower to the lender.
- They indicate the maturity of the debt—that is, when it must be paid back.
- They indicate the interest rate the borrower will pay to the lender and the type of interest paid ("fixed" over time versus "adjustable").
- They list any covenants—that is, agreements between the lender and borrower about limits on certain financial ratios that the borrower must maintain.
- They list any included call provisions. A call provision permits the borrower to redeem or pay back the debt prior to maturity. Usually, a call provision includes a premium in which the borrower pays more than the maturity value.
Now, take a few moments to reflect and answer the following questions.
Why would issuers want callability?
Why would lenders demand a premium to include them?
How do call provisions influence the risk of the debt to borrowers? To lenders?
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