Hostname: page-component-78c5997874-t5tsf Total loading time: 0 Render date: 2024-11-19T10:45:03.819Z Has data issue: false hasContentIssue false
  • English
  • Français

Refunding Discounted Debt: A Clarifying Analysis

Published online by Cambridge University Press:  06 April 2009

John D. Finnerty
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper demonstrates that refunding discounted debt represents a form of tax arbitrage that is profitable to taxpaying corporations when the present value of the additional tax shields, created through the refunding, exceeds the sum of the present value of the overall increase in pre-tax debt service requirements, after-tax transaction costs, and any tax incurred on the gain. The paper contrasts the factors that give rise to profitable opportunities to refund high-coupon debt and discounted debt. It also shows that, of the analytical approaches previously suggested for calculating the net advantage of refunding discounted debt, discounting the change in after-tax debt service payments at the after-tax cost of money for the refunding issue is the only one consistent with preserving debt service parity.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 21 , Issue 1 , March 1986 , pp. 95 - 106
Copyright
Copyright © School of Business Administration, University of Washington 1986

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

[1]Ang, J. S. “The Two Faces of Bond Refunding.” Journal of Finance, Vol. 30 (06 1975), pp. 869–874.CrossRefGoogle Scholar
[2]Ang, J. S. “The Two Faces of Bond Refunding: Reply.” Journal of Finance, Vol. 33 (03 1978), pp. 354–356.Google Scholar
[3]Bankruptcy Tax Act of 1980, Public Law Number 96–589, 12 31, 1980.CrossRefGoogle Scholar
[4]Boyce, W. M., and Kalotay, A. J.. “Optimum Bond Calling and Refunding.” Interfaces, Vol. 9 (11 1979), pp. 36–49.CrossRefGoogle Scholar
[5]Caks, J. “The Coupon Effect on Yield to Maturity.” Journal of Finance, Vol. 32 (03 1977), pp. 103–115.Google Scholar
[6]Caks, J. “Corporate Debt Decisions: A New Analytical Framework.” Journal of Finance, Vol. 33 (12 1978), pp. 1297–1315.CrossRefGoogle Scholar
[7]Dyl, E. A., and Spahr, R. W.. “Taxes and the Refunding of Discount Bonds.” Journal of Financial Research, Vol. 6 (Winter 1983), pp. 265–273.CrossRefGoogle Scholar
[8]Emery, D. R., and Lewellen, W. G.. “Refunding Noncallable Debt.” Journal of Financial and Quantitative Analysis, Vol. 19 (03 1984), pp. 73–82.CrossRefGoogle Scholar
[9]Harris, R. S. “The Refunding of Discounted Debt: An Adjusted Present Value Analysis.” Financial Management, Vol. 9 (Winter 1980), pp. 7–12.CrossRefGoogle Scholar
[10]Homer, S., and Leibowitz, M.. Inside the Yield Book. Englewood Cliffs, NJ: Prentice-Hall (1972).Google Scholar
[11]Joehnk, M. D.; Fogler, H. R.; and Bradley, C. E.. “The Price Elasticity of Discounted Bonds: Some Empirical Evidence.” Journal of Financial and Quantitative Analysis, Vol. 13 (09 1978), pp. 559–566.Google Scholar
[12]Johnson, R., and Klein, R.. “Corporate Motives in Repurchases of Discounted Bonds.” Financial Management, Vol. 3 (Autumn 1974), pp. 44–49.CrossRefGoogle Scholar
[13]Kalotay, A. J. “On the Advanced Refunding of Discounted Debt.” Financial Management, Vol. 7 (Summer 1978), pp. 14–18.Google Scholar
[14]Kalotay, A. J. “On the Management of Sinking Funds.” Financial Management, Vol. 10 (Summer 1981), pp. 34–40.CrossRefGoogle Scholar
[15]Laber, G. “Repurchases of Bonds through Tender Offers: Implications for Shareholder Wealth.” Financial Management, Vol. 7 (Summer 1978), pp. 7–13.Google Scholar
[16]Lewellen, W. G., and Emery, D. R.. “On the Matter of Parity among Financial Obligations.” Journal of Finance, Vol. 36 (03 1981), pp. 97–111.CrossRefGoogle Scholar
[17]Masulis, R. W. “The Effects of Capital Structure Change on Security Prices.” Journal of Financial Economics, Vol. 8 (June 1980), pp. 139–178.Google Scholar
[18]Masulis, R. W. “The Impact of Capital Structure Change on Firm Value: Some Estimates.” Journal of Finance, Vol. 38 (03 1983), pp. 107–126.Google Scholar
[19]Mayor, T. H., and McCoin, K. G.. “Bond Refunding: One or Two Faces?” Journal of Finance, Vol. 33 (03 1978), pp. 349–353.CrossRefGoogle Scholar
[20]Miller, M. H. “Debt and Taxes.” Journal of Finance, Vol. 32 (05 1977), pp. 261–275.Google Scholar
[21]Riener, K. D. “Financial Structure Effects of Bond Refunding.” Financial Management, Vol. 9 (Summer 1980), pp. 18–23.Google Scholar
[22]Tax Equity and Fiscal Responsibility Act of 1982, Public Law Number 97–248, 08 19, 1982.Google Scholar
[23]Tax Reform Act of 1984, Public Law Number 98–369, 07 18, 1984.CrossRefGoogle Scholar
[24]U.S. Master Tax Guide, 1983 edition. Chicago: Commerce Clearing House (1982), p. 265.Google Scholar