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How to Distinguish Between Bond Retirements & Bond Refunds

Original post by Victoria Duff of Demand Media

Check bond redemption provisions carefully before buying,

The maturity date is not the only time bond issuers pay off, or retire, their debt. Any bond, whether it is a Treasury bond, corporate bond or municipal bond, can have a provision for retiring the issue. Debt retirement methods include refunding or call dates and sinking funds. Serial bonds are long-term debt that is retired automatically according to a schedule. Even mortgage pass-through bonds, such as Government National Mortgage Association (GNMA) bonds, retire portions of the debt issue prior to maturity by paying interest and principal in each monthly payment.

Step 1

Look for the word "refunding." The bond may have the word "refunding" in its title such as "first and refunding mortgage bond" to indicate that it is being used to refund a previous issue of bonds. The prospectus lists the issue or issues that will be redeemed by the proceeds of the refunding bond.

Step 2

Look for a call date, also known as the refunding date. This is when the bond issuer can begin calling in bonds that are owned by bondholders. These bonds are redeemed by paying back the principal, and are retired. The entire issue may be redeemed or retired after the call date. The period of time between issue date and call date is called the call protection period.

Step 3

Look for a sinking fund, sinker or SF date. Sinking fund bonds have a provision that the issuer annually set aside money in a trust account specifically for the repurchase of bonds to retire the debt early. Sinking fund prices are generally below par, retiring the bond at a lower principal amount than if held to maturity. There is normally a limit on how many bonds may be retired through a sinking fund.

                   

Tips & Warnings

  • Debt retirement methods often increase the credit rating on long-term bonds because they mitigate some of the risk of default. It is theoretically riskier for a company to wait until the maturity date to pay the principal on an entire issue of long bonds. By that time, the company's financials may not be as strong as when the bond was issued. Additionally, if a company is forced to issue bonds when interest rates are high, it is to the company's advantage to be able to refund those bonds if interest rates decline.

References

About the Author

Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.

Photo Credits

  • Comstock/Comstock/Getty Images

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