2.3.1 Redemption or Prepayment

“Redemption” refers to the payment of all or a portion of the principal amount of a bond before the bond’s nominal maturity date. Early principal payment of obligations other than bonds, such as notes or an obligation to make lease or installment purchase payments, is referred to as “prepayment.” The two achieve the same functional outcome. In addition, the bond redemption is referred to as a “bond call” or a call. The issuer’s right to cause a redemption is referred to as the issuer’s “call right,” bonds subject to redemption are “callable,” bonds not subject to redemption are “noncallable,” and the amount of time between the issuance of a bond and the first date on which the bond can be redeemed is referred to as “call protection.” For example, if the bonds have “10 year call protection,” they cannot be called for 10 years after their issue. Redemption can be scheduled for a date or occasioned by an event outside of the issuer’s discretion (mandatory redemption) or can be done at the issuer’s option (optional redemption). The possibility that a bondholder may have its long term, fixed rate bond redeemed very early because of a redemption may affect the issue’s pricing.

Bond indentures generally require that bondholders be given notice of redemption at least 20 days in advance of the redemption date. The indenture may also allow a redemption notice to be cancelled or provide that redemption is conditioned upon the satisfaction of certain conditions, such as the bond trustee having received funds sufficient to pay the redemption price. If the notice is made conditional, the issuer can avoid a payment default if funds are not available. This may provide the issuer additional flexibility and allow it to avoid having a period during which a large amount of funds (such as the proceeds from a refunding) are uninvested. When an issuer redeems a bond, interest on the bond stops accruing and the holder has no further rights apart from the right to receive the redemption price.