Question-46: What do you mean by pre-refunded bonds?

Answer: In municipal bonds, on call date, instead of issuing new bonds to retire the debt, the municipality will issue bonds and use collected money to purchase enough risk-free securities to fund all the cash-flows on the existing bond issue. And then places these in an irrevocable trust. So the municipality would have two issues outstanding, but the old bond would be now called “prerefunded.” If municipality is using Treasury securities to prerefund the debt, hence, the cash-flows on the bond are guaranteed by Treasury obligations in the trust. Therefore they become AAA rated which now can trade at higher prices than previously.

Question-47: What do you mean by sinking-fund provision in case on bond market?

Answer: The sinking-fund provision, it requires that the borrower to retire a certain amount of the outstanding debt each year. These can be done either of the below ways.

• The firm can purchase the amount of bonds to be retired in the open market if their price is below par (lower than the face value).
• The company may make payments to the trustee who is empowered to monitor the indenture and who will call a certain number of bonds chosen by lottery.

Question-48: What are the advantages of the sinking-fund-provisions for investor?

Answer: There are many advantages of a sinking-fund provision from the investor’s side.

• Payment at maturity: The sinking-fund requirement helps in orderly retirement of the debt so that the final/last payment, at maturity, will not be big enough.
• Liquidity: Sinking fund provision enhances the liquidity of some debt
• Stable price: The prices of such bonds with such requirement are generally more stable. Because the issuer usually become an active participant on the buy side when prices fall.

Question-49: What is the effect on the yield with the bonds are having sinking-fund provisions?

Answer: Bonds, which are having the sinking fund provisions are usually have lower yield then the bond which does not have sinking fund.

Question-50: What is the disadvantage for the investor for having bonds with sinking fund provisions?

Answer: Since, bond can be retired early. So all the analysis done by the investor on that bond got wasted. That’s the reason it is required that these bonds have the higher coupon then the one which does not have this provision.