What is advance refunding ?
Among the different types of financial structuring that is available to entrepreneurs and businesses is the idea of advance refunding. The processes of engaging in advance refunding involves issuing new bonds that are used to repay the outstanding balance on older bonds prior to the call dates for the older bonds arrive. Here are some details about the way that advance refunding is usually structured to make sure that the customer of the bonds and the issuer are protected.
Because the fundamental principle of advance refunding engage to issuing new bonds to pay off outstanding bonds, there has to be some level of security for the issuer. This is accomplished by using the profits from the new issue to invest in government securities, effectively placing the profits in escrow. The newer bonds are purchased with a lower than the longer-maturing bond that it pays off. The interest that is generated off the new bonds is used to pay for the long-maturity bond prior to the first call date arrives. This process is a way of pre-refunding the older bond.
Advance refunding is a common method used by local governments to buy some time for the payment of the outstanding bonds, while still keeping status with outstanding debt. This enables the government entity to extend out the total indebtedness over a longer period, instead of having to pay a huge amount of debt in the present time. It is vital to note that while municipal bonds are tax-exempt; it cause revoking the status once the bond is used as part of an advance refunding strategy.
The basis of applying taxes to the bond is that in an advance refunding procedure, it is feasible for the local government to issue a huge amount of debt at lower rates. The local government can then invest the profits in investments that will pay off at a higher rate than the amount of the bonds. Imposing taxes on the bonds helps to restrain the creation of an irrational amount of debt that could eventually direct to a financial crisis for the municipality.
