Erschienen in:Columbia Business School Research Paper ; No. 13-65
Umfang:
1 Online-Ressource (63 p)
Sprache:
Englisch
DOI:
10.2139/ssrn.2305900
Identifikator:
Entstehung:
Anmerkungen:
Nach Informationen von SSRN wurde die ursprüngliche Fassung des Dokuments April 16, 2014 erstellt
Beschreibung:
Municipal bonds are often "advance refunded." Bonds that are not yet callable are defeasedby creating a trust that pays the interest up to the call date, and pays the call price. Newdebt, generally at lower interest rates, is issued to fund the trust. Issuing new securitiesto fund payments on existing liabilities generally has zero net present value. In this case,however, value is destroyed for the issuer through the pre-commitment to call. We estimatethat on average in an advance refunding the option value lost to the municipality isapproximately 0.75% of the par value not including fees. This translates to an aggregatevalue lost of $7-9 billion, depending on the option pricing model used, from 1995 to 2013for the bonds in our sample, which are roughly two-thirds of the advance refunded bondsthat traded during the period. The worst 5% of the transactions represent a destruction of$5.3-7.5 billion for taxpayers. We discuss various motives for the transaction, and argue thata major one is the need for short-term budget relief. Advance refunding enables the issuerto borrow for current operating activities in exchange for higher interest payments after thecall date. We find that municipalities in states with poor governance generally destroy morevalue by advance refunding