What Is a Pre-Refunding Bond?
A pre-refunding bond is a debt protection that is issued in order to fund a callable bond. With a pre-refunding bond, the issuer makes a decision to exercise its right kind to buy its bonds once more previous than the scheduled maturity date.
The proceeds from the issue of the lower yield and/or longer maturing pre-refunding bond will maximum frequently be invested in Treasuries (T-bills) until the scheduled identify date of the original bond issue occurs.
Key Takeaways
- A pre-refunding bond is issued by way of a company with the purpose of funding a callable bond at a later date.
- Pre-refunding is a method used by firms to effectively refinance their exceptional debt.
- In the intervening time period between the initial issue and the next callable bond issue, proceeds are held in safe Treasury securities.
Pre-Refunding Bonds Outlined
An entity that is scheduled to call its present bonds on a specified identify date can choose to issue new bonds of which the proceeds will probably be used to fulfill its passion payments and number one repayments on the present older bonds. The new bond that will probably be issued for this function is referred to as a pre-refunding bond. Pre-refunding bonds are generally issued by way of municipalities, and are secured by way of over the top credit-quality investments. The new bonds are known as refunding bonds, and their proceeds are used to pay off the older bonds, referred to as refunded bonds. The refunded bonds are paid off at a predetermined date, due to this fact, the time frame “pre-refunded” bond. Using pre-refunding bonds is most often a superb way for issuers to refinance their older bonds when interest rates drop.
A callable bond is one that can be “called” or repurchased from the secondary market by way of the issuer previous than the maturity date of the bond. When interest rates throughout the financial machine drops, bond issuers have an incentive to repurchase present bonds that experience higher affixed passion payments, and issue new bonds at the lower interest rates available in the market. This reduces the issuing entity’s worth of debt inside the kind of lower coupon payments to bondholders. Alternatively, to encourage patrons to shop for callable bonds, the ones bonds maximum frequently have a decision protection which prohibits the issuer from calling the bonds for a decided on time period, say 5 years. After those 5 years, the entity can exercise its rights to repurchase the bonds from {the marketplace}. The designated date after the verdict protection has ended that an issuer can identify its bonds is referred to as the principle identify date.
Other Issues
In anticipation of the long term date when the old-fashioned bonds will probably be repurchased, the proceeds from the new issues are held in escrow and invested in low yield alternatively over the top credit prime quality vehicles, harking back to cash investments or Treasury securities that mature around the equivalent time as the original bonds. On the first identify date or subsequent identify dates, the associated fee vary held in escrow are used to settle passion and number one tasks to patrons of the old-fashioned bond. The passion accumulated from the Treasury securities can repay the passion from the pre-refunded bond.
Like most municipal bonds, passion on pre-refunded bonds is exempt from federal earnings tax and a couple of state taxes. This tax get advantages makes pre-refunded bonds a gorgeous investment chance for patrons throughout the high-income tax brackets.
Example
For instance, suppose that all over June 2016, XYZ The town decided to call its 9% callable bond (to start with set to mature in 2019) for $1,100 on its first identify date of January 2017. In July, XYZ The town issued a brand spanking new bond yielding 7% and took all the proceeds from that bond and invested them into T-bills, ensuring that enough money may well be available to retire the issue come January.
