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 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.
Another type of advance refunding is an escrowed-to-maturity refunding. In this type of refunding, the issuer keeps the original payment schedule of the refunded bonds until maturity. This type of refunding is generally used to refund non-callable bonds or because bond covenants of the refunded issue are terminated once the bond is defeased.
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. REV P/R indicates that this is a revenue bond that has been pre-refunded at a do