Optimal Refunding Strategies, Transaction Costs, and the Market Value of Corporate Debt

David Ling ()

The Financial Review, 1991, vol. 26, issue 4, 479-500

Abstract: The primary purpose of this paper is to consider both qualitatively and quantitatively the effects of refunding transaction costs and interest rate uncertainty on optimal refunding strategies and the market value of corporate debt. A dynamic model of corporate bond refunding with transaction costs is developed that simultaneously solves for the optimal refunding strategy, the value of the refunding call option, the value of the bond liability to the firm, and the market (investor) value of the fixed-rate contract. The author provides examples in which the price of the callable bond does exceed the call price, and he examines whether or not typical levels of refunding costs are sufficient to explain the magnitude and duration of frequently observed premiums on callable corporate bonds. Copyright 1991 by MIT Press.

Date: 1991
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