LOS d: Explain the provisions for redemption and retirement of bonds.

Nonrefundable bonds may be called as long as the firm does not use less expensive debt to do so. They may be refunded with outside capital, just not cheaper debt.

Refunding from a new debt issue at a higher interest rate is not prohibited, however their purchase cannot be funded by the simultaneous issuance of lower coupon bonds.

A sinking fund actually retires the bonds based on a schedule. This can be accomplished through either payment of cash or through the delivery of securities. An accelerated sinking fund provision allows the company to retire more than is stipulated in the indenture.

These bonds have a bullet maturity structure because the issuer has agreed to pay the entire amount borrowed in one lump-sum payment at maturity.

When redemption funds are obtained as a result of a forced sale of assets for deregulatory purposes, the funds can be used to redeem bonds at the special redemption price, which are typically par value.

Regular redemption price refers to bonds being called according to the provisions specified in the bond indenture. When bonds are redeemed to comply with a sinking fund provision or because of a property sale mandated by government authority, the redemption prices (typically par value) are referred to as "special redemption prices." There is no such thing as a specific redemption price.

When bonds are redeemed under the call provisions specified in the bond indenture, these are known as regular redemptions and the call prices are referred to as regular redemption prices which can be either at a premium or at par.

Coupon Treasury bonds and most corporate bonds are non-amortizing securities because they pay only interest until maturity. At maturity these bonds repay the entire par value or face value. A MBS is backed by pools of loans that generally have a schedule of partial principal payments, making these securities amortizing securities. A sinking fund provision is another example of an amortizing feature of a bond. This feature is designed to pay a part or the entire total of the issue by the maturity date.

Panelist 1 is incorrect. These securities do not have a bullet maturity structure. The payments are structured so that the loan is paid off when the last loan payment is made.

Panelist 2 is incorrect. If coupon Treasury bonds or corporate bonds are issued with the terms specifying that the principal be repaid over time at the option of the issuer, then these bonds are callable bonds – the call provision grants the issuer an option to retire part of the issue or the entire issue prior to the maturity date. On the other hand, if the principal is to be repaid over time at the option of the bondholder, then these bonds are putable bonds – the put provision entitles the bondholder to put (sell) the issue back to the issuer at the put price (if interest rates increase and the bond’s price declines below the put price).

Customarily, when a bond is called on the first permissible call date, the call price represents a premium above the par value. If the bonds are not called entirely or not called at all, the call price declines over time according to a schedule. For example, a call schedule may specify that a 20-year bond issue can be called after 5 years at a price of 110. Thereafter, the call price declines by a dollar a year until it reaches 100 in the fifteenth year, after which the bonds can be called at par

A deferred call provision means the issue is initially (say, for the first 5 to 7 years) non-callable, after which time it becomes freely callable. In other words, there is a deferment period during which time the bond cannot be called, but after that, it becomes freely callable.

Call provisions give the issuer the right (but not the obligation) to retire all or a part of an issue prior to maturity. If the bonds are “called,” the bondholder has no choice but to turn in his bonds. Call features give the issuer the opportunity to get rid of expensive (high coupon) bonds and replace them with lower coupon issues in the event that market interest rates decline during the life of the issue.

Call provisions do not pertain to maturity. A put provision gives the bondholders certain rights regarding early payment of principal.

This statement is accurate. When bonds are redeemed to comply with a sinking fund provision or because of a property sale mandated by government authority, the redemption prices (typically par value) are referred to as "special redemption prices." When bonds are redeemed under the call provisions specified in the bond indenture, these are known as a regular redemptions and the call prices are referred to as "regular redemption prices." 

The other statements are false. A sinking fund is a type of redemption, which refers to the retirement of bonds. An investor concerned about premature redemption would prefer a noncallable bond because a noncallable bond cannot be called for any reason. A bond that is callable but nonrefundable can be called for any reason other than refunding. The term refunding specifically means redeeming a bond with funds raised from a new bond issued at a lower coupon rate. A nonrefundable bond can be redeemed with funds from operations or a new equity issue.