Types of Refunding
When the bonds to be refinanced mature or are called within 90 days after the issuance of the refunding bonds, the refunding is referred to as a current refunding. An advance refunding refers to one in which more than 90 days elapse before the refunded bond may be retired matures or can be called.
There are two types of advance refunding. An advance refunding that redeems the refunded bonds at the earliest possible call date is called a pre-refunding. The purpose of a pre-refunding is to reduce interest rate payments or shorten the debt maturity schedule. For example, if Popperville has a bond paying 5%, and interest rates decline, Popperville can issue new bonds at a lower interest rate, thereby reducing its interest expense. The proceeds of the new refunding bonds will be used to cover the interest payments of the refunded bonds until they can be called. Depending on the terms of the issue, the price that Popperville will pay its bondholders to call the refunded bonds (the call price) may be above par. Bond listings will include “P/R” for quotes of pre-refunded bonds. For example, P/R @ 101 would mean that the bond had been pre-refunded at 101% of par. The listing will also include the date on which the bonds will be redeemed by the issuer.
Example Question 1
A bond is listed as LOUSIANA PUB WKS REV P/R @ 104 3.75 2/01/2016. This quote indicates that the bond:
- A. Is callable to 3.75%
- B. Has a yield to maturity of 3.75%
- C. Is partially refundable in 2016
- D. Is pre-refunded at a price above par
Answer: D
Explanation: REV P/R indicates that this is a revenue bond that has been pre-refunded at a dollar price of $1,040 (104 bond points indicates a price of 104% of par). Since it has been pre-refunded, neither the maturity date nor yield to maturity is relevant any longer to an investor. The date of 2016 is the call date at which the refunded bonds will be returned to the issuer. The inte