TAILIEUCHUNG - A COMPREHENSIVE QUANTITATIVE MODEL FOR ANALYZING BOND REFUNDING DECISIONS

When a corporation refunds a bond issue, choices have to be made between fixed-rate and floating-rate bonds based on expectations of future interest rates. Whether it is financially viable to refund a bond issue depends on many factors, including the magnitude of the decline in interest rates, the call premium, flotation costs, overlapping interest and the corporate tax rate, and all of these factors should be considered in the decision making process. This paper presents a comprehensive quantitative model that will assist the corporation to decide whether to refund and to select the best refunding option. Unlike prior studies, the model developed in this paper is. | Journal of Financial and Strategic Decisions Volume 11 Number 2 Fall 1998 A COMPREHENSIVE QUANTITATIVE MODEL FOR ANALYZING BOND REFUNDING DECISIONS Lawrence S. Tai and Zbigniew H. Przasnyski Abstract When a corporation refunds a bond issue choices have to be made between fixed-rate and floating-rate bonds based on expectations of future interest rates. Whether it is financially viable to refund a bond issue depends on many factors including the magnitude of the decline in interest rates the call premium flotation costs overlapping interest and the corporate tax rate and all of these factors should be considered in the decision making process. This paper presents a comprehensive quantitative model that will assist the corporation to decide whether to refund and to select the best refunding option. Unlike prior studies the model developed in this paper is capable of handling a variable overlap period floating-rate bonds and old and new bonds with different terms to maturity. INTRODUCTION When interest rates fall steadily and continuously corporations may be able to save money by refunding their existing bond issues. According to Boyce and Kalotay 2 the accepted wisdom is to refund a bond issue when interest rates fall 1 below the coupon rate on the existing bond. However the refunding decision is in reality a complicated one. Whether it is financially viable to refund a bond issue depends on many factors including the magnitude of the decline in interest rates the call premium flotation costs overlapping interest and the corporate tax rate and all of these factors should be considered in the decision making process. There are basically two types of bonds available to corporations fixed and floating. For fixed-rate bonds interest rates are fixed over the life of the bond. For floating-rate bonds the index used to determine the interest rate includes LIBOR London Interbank Offer Rate T-bill Treasury bill and T-bond Treasury bond . Interest payments on these bonds are .

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