Debt Management

Don’t Waste a Free Lunch: Managing the Advance Refunding Option

Journal of Applied Corporate Finance

Optimal Municipal Bond Portfolios For Dynamic Tax Management

Journal Of Investment Management, Vol. 14, No. 1, (2016), pp. 81-99

Tax-Efficient Trading of Municipal Bonds

Financial Analysts Journal Volume 72 · Number 1 ©2016 CFA Institute

Making Sense of the Make-Whole Call, From its Origins to BABs

The Bond Buyer (July 26, 2010)

Why investors don’t charge for make-whole calls

Calling and Refunding

Making the Right Call
Credit (October 2010)
The tendency among municipal issuers to call their bonds early in the belief they are refunding on better terms often results in the loss of future value, to the detriment of the taxpayer.

Related Analytics: DebtPays™, Bond Buyer Online's Advance Refunding Calculator

What Makes the Municipal Yield Curve Rise?
The Journal of Fixed Income (Winter 2008)
The municipal yield curve’s permanent upward slope is a logical consequence of that curve being comprised of bonds callable at or close to par after 10 years. Previous researchers have overlooked this simple, straightforward explanation.

Callable Bonds: Better Value Than Advertised?
Journal of Applied Corporate Finance (Summer 2008)
On an after-tax basis, callable bonds can be a good deal for both issuer and investor.

Optimal Mortgage Refinancing: Application of Bond Valuation Tools to Household Risk Management
Applied Financial Economics Letters (Vol. 1, 2008)
Concepts long known from research on callable bonds help provide a rigorous and robust solution to the elusive question of when is it optimal for a borrower to refinance a residential mortgage.

Refunding Efficiency: A Generalized Approach
Applied Financial Economics Letters (Vol. 3, 2007)
This paper sets out an improved method for determining when it’s efficient to call and refinance a bond, by correctly accounting for the call option value of both the new bond and the outstanding bond.

When It’s Time to Get off the Tree
Financial Engineering News (November/December 2006)
Options embedded in mortgage loans and callable bonds often get exercised either too early or too late. Longer lockout periods or European-style call options can help debt managers minimize the potential damage from suboptimal exercise.

Insuring Callable Bonds: Selecting the Right Payment Plan
The Journal of Risk Finance (Spring 2003)
An option valuation framework lets callable bond issuers meaningfully compare the cost of bond insurance purchased through periodic payments over the bond’s life, versus paying a single up-front premium.

Ratchet Bonds: Maximum Refunding Efficiency at Minimum Transaction Cost
Journal of Applied Corporate Finance (Spring 1999)
The ratchet bond structure, whose indexed coupon resets periodically only when rates fall, represents a superior alternative to callable bonds. Because it automatically lowers interest payments when rates decline, the inefficiencies and transaction costs associated with calling and refunding are eliminated.

The Timing of Advance Refunding of Tax-Exempt Municipal Bonds
Municipal Finance Journal (Summer 1998)
A municipal issuer’s decision whether to advance refund a bond should rest on comparing the cash-flow savings from refunding to the embedded total option value in the bond. Once this ratio reaches a specified threshold, the trigger should be pulled.

Refunding Tax-Exempt Corporate Bonds in Advance of the Call
The Financier (February 1994)
Practical, analytic and regulatory aspects of refunding tax-exempt corporate bonds are examined through a case study of a Florida Power & Light tax-exempt bond tender for which AKA served as advisor.

The Management of Sinking Funds: The World Bank Experience
Journal of Fixed Income (June 1993)
An illustration of the complexities and challenges of sinking fund management, showing the power of the refunding efficiency concept.

The Sure Thing – Bond Refunding: How Operations Research Made Its Mark on Wall Street
OR/MS Today (April 1993)
How Bell System treasurers came to embrace Dr. Kalotay’s idea of refunding efficiency.

Embedded Call Options and Refunding Efficiency
Advances in Futures and Options Research (Vol. 3, 1988)
A bond should be called when the company’s refunding rate is below a specified target rate determined by interest rate volatility plus several factors whose combined impact is captured in a single percentage figure known as refunding “efficiency.” This paper explains how to compute refunding efficiency and the target refunding rate.

Making Debt Pay
Forbes (August 8, 1988)
A concise, one-page profile of how Dr. Kalotay’s early work on refunding efficiency helped Salomon Brothers dominate the refinancing segment of the corporate debt market and make inroads among international bond issuers seeking to manage currency risk.

Optimum Bond Calling and Refunding
Interfaces (November 1979)
One of the earliest published explanations of the concept of efficiency in calling and refunding bonds, this paper explains how analytical techniques developed at Bell Labs and AT&T influenced the Bell System’s decisions to refund more than $2 billion of callable debt during 1976 and 1977.

Tax Differentials and Callable Bonds
Journal of Finance (September 1979)
When a borrower has a higher tax rate than the lender; on an after-tax basis both parties benefit from a callable bond compared with either a noncallable or putable one. Because corporations are taxable and major lenders such as pension funds are not, this explains the prevalence of callable corporate bonds and the rarity of putable bonds.

Structured Transactions and Interest Rate Derivatives

Insuring Callable Bonds: Selecting the Right Payment Plan
The Journal of Risk Finance (Spring 2003)
An option valuation framework lets callable bond issuers meaningfully compare the cost of bond insurance purchased through periodic payments over the bond’s life, versus paying a single up-front premium.

Putable/Callable/Reset Bonds: Inter-market Arbitrage with Unpleasant Side Effects
Journal of Derivatives (Summer 1999)
A form of synthetic put bonds that became popular in the late 1990s, putable/callable/reset bonds (PCRBs) are of dubious value as a debt management tool.

How to Succeed in Derivatives without Really Buying
Journal of Applied Corporate Finance (Fall 1993)
Understanding the derivatives market can help a treasurer distinguish between good and bad pricing in the cash market. By using a synthetic benchmark for comparison, Andrew Kalotay Associates persuaded Niagara Mohawk to reject a seemingly attractive refunding transaction that would have squandered roughly $1.5 million in potential cash savings.

The Valuation and Management of Bonds with Sinking Fund Provisions
Financial Analysts Journal (March/April 1992)
Sinking fund bonds incorporate interrelated options whose value is affected by market purchases on the part of either the issuer or investors. Valuation methods described in this paper lead to concrete guidance for investors to maximize the value of their bonds, and for issuers to optimize benefits from the various options they possess.

Tax-Driven Transactions

Premium Debt Swaps: The Best of Both Worlds?
Financial Management (Autumn 1998)
An analysis of United Parcel Service’s par-for-par swap for $700 million of premium debt in 1998 reveals how debt management innovations reflect both issuers’ cash flow considerations and evolving tax laws and accounting standards.

A Tale of Two Bond Swaps
Journal of Financial Engineering (December 1992)
Issuing longer-term discount bonds to retire outstanding discount bonds can prove profitable when the corporate tax rate exceeds the tax rate of a large enough set of investors.

Tax Differentials and Callable Bonds
Journal of Finance (September 1979)
When a borrower has a higher tax rate than the lender, on an after-tax basis both parties benefit from a callable bond compared with either a noncallable or putable one. Because corporations are taxable and major lenders such as pension funds are not, this explains the prevalence of callable corporate bonds and the rarity of putable bonds.

Accounting and Regulatory Finance

Testing Hedge Effectiveness for FAS 133: The Volatility Reduction Measure
Journal of Applied Corporate Finance (Winter 2001)
The VRM, a ratio-based statistic invented and patented by Andrew Kalotay Associates, fulfills the spirit of FASB’s recommendations for hedge effectiveness testing, while correcting their major shortfalls. It can be used for both prospective and retrospective testing.

Earnings Impact of Derivatives under Hedge Accounting
FAS 133 and the New Derivatives Accounting Landscape (Fall 2001)
A demonstration of how to project the earnings impact of a highly effective hedge, using accepted risk management methods. While the illustrative case involves a fixed coupon bond hedged with a plain-vanilla interest rate swap, the approach is completely general and can be applied to a broad range of asset classes and hedging strategies.

The Volatility Reduction Measure
Derivatives Strategy (March 2001)
An Andrew Kalotay Associates innovation, the VRM pinpoints the degree to which a hedge offsets the volatility of a particular asset, liability or portfolio. Retrospective testing on historical data and prospective testing through Monte Carlo simulation can be combined into a single hedge effectiveness score by properly weighting the inputs into the VRM formula.

FAS 133: Hedge Effectiveness Testing
Reuters Risk Review (Vol. 2, 2000)
In its guidelines on how to test for hedge effectiveness, FASB recommended two alternatives: the “80/125 Rule” and correlation (R-squared). Each has serious conceptual and practical flaws. In contrast, the Volatility Reduction Measure introduced by Andrew Kalotay Associates is rigorous, defensible and reasonable, as well as simple to apply.

Refunding Considerations under Rate-Base Regulation
Financial Management (Autumn 1984)
Several public utility commissions adopted in their rate-making policies this paper’s recommendations for treating the call premium when a utility retires debt at a price above par.

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