7.18.2005

Q&A: What's the difference between a non-callable bond...

... and a non-refundable bond?

Non-refundable prevents redemption only from certain sources, namely the proceeds of other debt issues sold at a lower cost of money (ie. when interest rates decline). A non-refundable bond can be callable if cash flows are from other sources, such as operations, common stock sale, or sale of property.

Non-callable is much more absolute than refunding protection - it has complete protection against early retirement.

Bonus Points

Provisions for paying off bonds

  • A call provision is the right of the issuer (not obligation) to retire the issue prior to the stated maturity date.
    • Bonds can be called in whole or in part.
    • Typically, call provisions have a deferment period (ie. the issuer may not call the bond for a number of years until a specified first call date is reached)
    • Typically, a call schedule specifies a number of call dates, and sets a call price for each call date. The call price at the first call date generally has a premium over the par value.
    • Call provision gives the corporation the option to force retirement of the entire debt issue prior to maturity, whereas a put provision gives the bondholder the same option. (put valuable if interest rates have gone up and bond prices have gone down.)
  • A refunding provision permits the issuer to redeem bonds using proceeds from issuing lower cost debt obligations ranking equal to or SUPERIOR to the original debt.
  • A prepayment option allows principal repayment prior to the scheduled data (ie. a prepayment). Typically the price at which a loan is prepaid is par value. Commonly used in amortizing securities that are backed by loans (e.g. mortgage and car loans).
  • A sinking fund provision allows to retire a specified portion of the bond each year to reduce credit risk. The issuer can fulfill the requirement by
    • Making a cash payment of the required sinking fund to the trustee, who then retires the bonds using a lottery; or
    • Purchase bonds in the open market, and deliver them to the trustee.
  • Index amortizing notes: principal repayments are made prior to the started maturity date based on the prevailing value for some reference rate. The principal payments are structured to accelerate when the reference rate is low.

Category: C++ Quant > Debt

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