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11.5 Calls and puts in debt instruments
Publication date: 14 Oct 2019
us IFRS & US GAAP guide
IFRS and US GAAP have fundamentally different approaches to assessing whether calls and puts embedded in debt host instruments require bifurcation. Additionally, under IFRS, the embedded derivative analysis is only performed for the issuer of the debt instrument and not the holder, since there is no assessment of embedded derivatives for financial assets (see SD 7.7).
US GAAP
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Multiple tests are required to evaluate whether an embedded call or put (i.e., a feature that can accelerate repayment of principal of a debt instrument) is clearly and closely related to the debt host. If any of the conditions outlined in the following tests occurs, the call or put is not clearly and closely related to the debt host and bifurcation is generally required.
Test 1—Upon exercise of the call or put, a debt instrument’s settlement amount changes based on anything other than interest rates or credit risk.
| Calls, puts, or prepayment options embedded in a hybrid debt instrument are closely related to the debt host instrument if either (1) the exercise price approximates the amortized cost on each exercise date or (2) the exercise price of a prepayment option reimburses the lender for an amount up to the approximate present value of the lost interest for the remaining term of the host contract. Once determined to be closely related as outlined above, these features do not require bifurcation.
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Test 2—A debt instrument involves a substantial premium or discount and the call or put that can accelerate repayment of principal is contingently exercisable.
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Test 3—If the only underlying is an interest rate or interest rate index and either (a) there is a substantial premium or discount (but the put or call is not contingently exercisable), or (b) there is no substantial premium or discount, an additional test is required. If the debt instrument can either (a) be settled in such a way that the holder would not recover substantially all of its recorded investment or (b) the embedded derivative would both (1) at least double the holder’s initial rate of return and (2) the resulting rate of return would be double the then current market rate of return, then the call or put is not clearly and closely related. However, certain exceptions are provided for this test. See FG 1.6.1.2.
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