Refunded Bond

What Is a Refunded Bond?

Refunded bonds, which are a subset of the municipal and corporate bond classes, are bonds that have their principal cash amount previously held aside by the original issuer of the debt. This is many times achieved using a sinking fund, an account a firm purposes to set to the side money reserved to pay off the debt from a bond or other debt issue. The sinking fund gives bond investors an additional element of security.

A refunded bond ought not be mistaken for a pre-refunding bond, which is a debt security that is issued to fund a callable bond. With a pre-refunding bond, the issuer chooses to exercise its right to buy its bonds back before the scheduled maturity date.

Grasping Refunded Bond

Refunded bonds are low-risk investments on the grounds that the principal amount is now accounted for. The funds required to pay off refunded bonds are held in escrow until the maturity date, for the most part by purchasing Treasury or agency paper. Refunded bonds can likewise be alluded to as pre-refunded bonds or prior issues.

By definition, the term "refunding" means refinancing another debt obligation. It isn't unfathomable for municipalities to issue new bonds to raise funds to retire existing bonds. The bonds which are issued to refund more seasoned bonds are called refunding bonds or pre-refunding bonds. The outstanding bonds which are paid off utilizing proceeds from refunding bonds are called refunded bonds. Put in an unexpected way, a refunded bond can be understood as a bond of a prior issue that is refinanced utilizing a refunding bond.

Payments on refunded bonds are viewed as equivalent in quality to Treasuries, which are backed by the full faith and credit of the U.S. government, subsequent to going through a binding escrow account. Refunded bonds will typically be 'AAA' rated due to this cash backing system and, in that capacity, will offer minimal premium to equivalent-term Treasuries. Furthermore, refunded bonds keep a tax-exempt status for federal tax purposes.

Who Uses Refunded Bonds

A refunded bond is originally issued by a municipal, state, or nearby government authority as either a general obligation bond or a revenue bond. The inverse relationship that exists between bond prices and interest rates means that while prevailing interest rates in the economy drop, prices on outstanding bonds will increase. This likewise means that an issuer of an existing bond will be stuck paying a higher interest rate than what issuers of new bonds are paying their investors. Since bond issuers hope to borrow funds with as low interest as could really be expected, they will typically reclaim an existing bond before it develops and refinance the bond with a lower interest rate that mirrors the lower rates in the market. In effect, the proceeds from the issuance of the new lower interest rate bonds will be utilized to pay off the higher interest rate bonds.

An issuer that needs to exploit lower interest rates during the call protection period might issue refunding municipal bonds. The proceeds from the new issue will be put in an escrow account until the call date of the refunded bond is reached. More specifically, the proceeds from the refunding bond are utilized to purchase Treasury securities, which are stored and held in escrow. The interest generated from the treasuries assists in paying the interest on the refunded bonds up to the call with dating, at which point the proceeds held in escrow will be utilized to pay off existing holders of the refunded bond. The date of refunding will typically be the principal callable date of the bonds.

Callable Bonds and Refunding

Callable bonds frequently have a call protection period, stated in the trust indenture, that prevents a bond issuer from resigning its bonds right on time before a predetermined time. For instance, a 10-year callable bond might have a four-year call protection period. This means the issuer can't reclaim the bonds for a long time, after which they might decide to exercise its right to call the bond on the given first call date — the principal date a bond can be called after the call protection period lapses.

Features

• Refunded bonds are low-risk and frequently viewed as equivalent in quality to U.S. Treasuries.
• A refunded bond will utilize a sinking fund to hold in escrow the principal amount, making these bonds safer to investors.
• Refunded bonds keep a cash amount held aside by the original issuer of the debt to repay its principal.