Advance Refunding

Advance Refunding Definition

Advance refunding is a process in which the proceeds from the bond are used to clear up the debt associated with another bond. Here, the new bonds are issued at a lower price, and this mechanism is used to get rid of the higher interest cost by investing in new bonds whose interest cost is less as compared to the old bond.

Explanation

Advance-Refunding

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Source: Advance Refunding (wallstreetmojo.com)

How does it Work?

Examples of Advance Refunding

Difference Between Advance Refunding and Current Refunding

Benefits

  • Municipalities can take advantage of the lower interest rate of the market.
  • It helps to refinance the management of the entire bond.
  • Bond management can be easily done at a smooth pace.
  • It helps to make a plan for the structuring of the bonds in the municipal.
  • It helps to reduce the interest cost.
  • By using this process, the proceeds of the bonds can be used to eliminate the outstanding debts from the old bonds.
  • By advance refunding, the municipal personal can issue the bonds with the lower interest rate in the market, but the issue value can be higher, and then the proceeds are used to clear the outstanding value.

Limitations

  • This is no longer tax-free.
  • The risk associated is high when the government bonds are converted to Agency securities, and their credit rating is higher after that.
  • The underwriters are hired to complete the entire process.
  • This can also be illegal when it comes to price manipulation.
  • It is said to be applied after the 90 days’ time has expired. The government should call for earlier dates to declare the advance refunding mechanism for better planning.
  • The advance refunding mechanism can sometimes be a reason for the significant less issuance of the bonds in the market because it may hurt the sentiments of the bondholders who were getting higher interest earlier.

Conclusion

  • Advance refunding is although a very nice mechanism for the municipal bonds or government bonds, but it has its own limitation as well. The bondholders can get demotivated by investing in government bonds. The price of these bonds can be manipulated to either control the supply or to increase the investment in the non-government bonds whose returns and risks both are high.
  • This should be done very carefully by hiring experts because it may attract some legal consequences in the future. This mechanism is very helpful for the issuer of the bonds because they can call for the issuance of the new bonds with lower interest in the market.

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