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Abstract:
Buying a home is the single biggest investment decision for most Americans. Because most buyers do not have the cash to pay the purchase price upfront, they are obliged to take out mortgage loans. The result has been demand for a wide range of mortgage products to suit borrowers’ varied cash flow and risk preferences.

Increased choice, however, introduces complexity - choosing the right mortgage and managing it can be a challenge. Fortunately, there are well-understood tools that corporate and municipal treasurers use to manage debt and these can be adapted for homeowners managing their mortgages. Corporate treasurers are responsible for managing their firms’ borrowing profiles and strategy. Just like a homebuyer, they need to decide when to borrow, how to structure debt, when to refinance debt and when to pay off debt. If they do this well, they can save their firm a lot of money; if not, the costs could be considerable. Homeowners face similar challenges in managing their home loans, and they can apply the same techniques used by corporate treasurers.

Mortgages, Financial Literacy, Refinancing

Abstract:
Transaction costs that occur when refunding diminish the value of the call option, and their effect should be factored in at the time of issuance. One way of avoiding such costs is to issue ratchet bonds essentially one-way floaters that automatically reset lower when rates decline, thus delivering the benefits of callable bonds while eliminating transaction costs. Refunding decisions should be made using the concept of call efficiency, which compares the savings (net of transactions costs) from calling to the loss of option value. The latter should also account for any option that is built into the replacement issue. In perfect markets with no taxes or transactions costs, the average corporate issuer should be indifferent between issuing callable bonds or their noncallable equivalent. But corporate taxes, together with risk management considerations, can lead some issuers to prefer callable bonds, possibly with coupons that otherwise would be unacceptably high. This article addresses two main questions about the structuring and refunding of callable bonds. The first concerns the value of the call option: At the time of issuance, does it make sense to accept the coupon premium for the option being acquired? The second concerns the optimal timing of a refunding: At refunding, do the cash flow savings provide adequate compensation for the option that is being exercised and hence given up? Callable bonds allow issuers to manage interest rate risk in the sense that if rates decline, the bonds can be redeemed and replaced with lower-cost debt. Investors demand a coupon premium for giving issuers this option; and when deciding whether to issue callable or noncallable bonds, the issuing companies must determine whether it's worth paying the coupon premium.

Abstract:
In a recent transaction, a corporation offered to exchange an outstanding issue selling at a premium for a new issue of somewhat longer maturity and slightly higher market value. Why would an issuer offer such a deal? This paper examines the transaction and explains its motivation, which is based on accounting and tax considerations. In addition, the paper provides a historical perspective of debt exchanges and describes the sequence of innovations and the resulting legislative responses that led up to this transaction.