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A bond that retires another bond before the first bond matures. A company
may issue a refunding bond for a number of reasons, but mainly because of a
decline in interest rates, which reduces the cost of funding. Refunding bonds
deprive bondholders of the first bond from future coupon payments to which
they would otherwise of have been entitled. Most bonds are nonrefundable for
at least five or 10 years after issue, but a refunding bond may be issued
afterward.
A bond that is issued for the purpose of retiring an outstanding bond. Issuers
refund bond issues to reduce financing costs, eliminate covenants, and alter
maturities.
This action is particularly common under the following circumstances:
The bond issuer has experienced a credit rating increase, and so can
expect to obtain debt at a lower cost than had been the case when the
existing bonds were issued.
There is a substantial period of time over which the bond issuer will
have to continue paying interest on the existing bonds, so refunding them
will easily offset any related transaction fees.
Interest rates are now at a lower level than they were when the bonds
were issued.
The bond issuer can obtain replacement debt that carries fewer
restrictions than are imposed in the bond agreements. For example, a bond
agreement may state that no dividends can be issued for as long as the
bonds are outstanding. Shareholders may pressure management to recall
these bonds in order to issue them a dividend.
Most of the preceding points should make it clear that bond refunding is
triggered by the opportunity to refinance at lower rates. Only in the last case
do other factors have an impact on the refunding decision.
Call provision
A clause in a loan instrument that gives the lender the right to accelerate the
debt upon the occurrence of certain conditions. These might include filing for
bankruptcy (illegal, but it's in all the promissory notes anyway), reduction in