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http://ssrn.com/abstract=2305900
 
 

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Advance Refundings of Municipal Bonds


Andrew Ang


Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Richard C. Green


Carnegie Mellon University - David A. Tepper School of Business

Yuhang Xing


Rice University

September 12, 2013

Columbia Business School Research Paper No. 13-65

Abstract:     
Municipal bonds are often "advance refunded.'' Bonds that are not yet callable are defeased by creating a trust that pays the interest up to the call date, and pays the call price. New debt, generally at lower interest rates, is issued to fund the trust. Issuing new securities generally has zero net present value. In this case, however, value is destroyed for the issuer through the pre-commitment to call. We estimate that for the typical bond in an advance refunding, the option value lost to the municipality is approximately 1% of the par value not including fees. This translates to an aggregate value lost of over $4 billion from 1996 to 2009 for the bonds in our sample, which are roughly half of the universe of advance refunded bonds that traded during the period. The worst 5% of the transactions represent a destruction of $2.9 billion for taxpayers. We discuss various motives for the transaction, and argue that a major one is the need for short-term budget relief. Advance refunding enables the issuer to borrow for current operating activities in exchange for higher interest payments after the call date. We find that municipalities in states with poor governance generally destroy the most value by advance refunding.

Number of Pages in PDF File: 59

Keywords: municipal bonds, advance refunding, public finance

JEL Classification: G12, G28, H20, H24

working papers series


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Date posted: August 5, 2013 ; Last revised: September 23, 2013

Suggested Citation

Ang, Andrew and Green, Richard C. and Xing, Yuhang, Advance Refundings of Municipal Bonds (September 12, 2013). Columbia Business School Research Paper No. 13-65. Available at SSRN: http://ssrn.com/abstract=2305900 or http://dx.doi.org/10.2139/ssrn.2305900

Contact Information

Andrew Ang
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Richard C. Green (Contact Author)
Carnegie Mellon University - David A. Tepper School of Business ( email )
315B Schenley Park
Pittsburgh, PA 15213-3890
United States
412-268-2302 (Phone)
412-268-7064 (Fax)
Yuhang Xing
Rice University ( email )
6100 South Main Street
Houston, TX 7705-1892
United States
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