/woman-checking-stocks-and-shares-data-with-smartphone-in-city-949366598-53708ffce31342ba9506ea8733bf6ae7.jpg "Pre-Refunding Bond Definition 1")
What Is a Pre-Refunding Bond?
A pre-refunding bond is a debt safety that’s issued with a view to fund a callable bond. With a pre-refunding bond, the issuer decides to train its proper to purchase its bonds again earlier than the scheduled maturity date.
The proceeds from the problem of the decrease yield and/or longer maturing pre-refunding bond will normally be invested in Treasuries (T-bills) till the scheduled name date of the unique bond concern happens.
Key Takeaways
- A pre-refunding bond is issued by a company with the aim of funding a callable bond at a later date.
- Pre-refunding is a method utilized by companies to successfully refinance their excellent debt.
- Within the interim interval between the preliminary concern and the next callable bond concern, proceeds are held in secure Treasury securities.
Pre-Refunding Bonds Defined
An entity that’s scheduled to name its present bonds on a specified name date can select to concern new bonds of which the proceeds might be used to satisfy its curiosity funds and principal repayments on the prevailing older bonds. The brand new bond that might be issued for this goal is known as a pre-refunding bond. Pre-refunding bonds are usually issued by municipalities, and are secured by excessive credit-quality investments. The brand new bonds are often known as refunding bonds, and their proceeds are used to repay the older bonds, known as refunded bonds. The refunded bonds are paid off at a predetermined date, therefore, the time period “pre-refunded” bond. Utilizing pre-refunding bonds could be a good technique for issuers to refinance their older bonds when rates of interest drop.
A callable bond is one that may be “referred to as” or repurchased from the secondary market by the issuer earlier than the maturity date of the bond. When rates of interest within the financial system drops, bond issuers have an incentive to repurchase present bonds which have larger affixed curiosity funds, and concern new bonds on the decrease rates of interest available in the market. This reduces the issuing entity’s value of debt within the type of decrease coupon funds to bondholders. Nonetheless, to encourage buyers to buy callable bonds, these bonds normally have a name safety which prohibits the issuer from calling the bonds for a selected time period, say 5 years. After these 5 years, the entity can train its rights to repurchase the bonds from the market. The designated date after the decision safety has ended that an issuer can name its bonds is known as the primary name date.
Different Concerns
In anticipation of the longer term date when the previous bonds might be repurchased, the proceeds from the brand new points are held in escrow and invested in low yield however excessive credit score high quality autos, corresponding to money investments or Treasury securities that mature across the identical time as the unique bonds. On the primary name date or subsequent name dates, the funds held in escrow are used to settle curiosity and principal obligations to buyers of the previous bond. The curiosity amassed from the Treasury securities pays off the curiosity from the pre-refunded bond.
Like most municipal bonds, curiosity on pre-refunded bonds is exempt from federal earnings tax and a few state taxes. This tax profit makes pre-refunded bonds a lovely funding possibility for buyers within the high-income tax brackets.
Instance
For instance, suppose that in June 2016, XYZ Metropolis determined to name its 9% callable bond (initially set to mature in 2019) for $1,100 on its first name date of January 2017. In July, XYZ Metropolis issued a brand new bond yielding 7% and took all of the proceeds from that bond and invested them into T-bills, guaranteeing that sufficient cash can be accessible to retire the problem come January.