Debt for Bond Swap

What Is a Debt for Bond Swap?

A debt for bond swap is a debt swap involving the exchange of a new bond issue for similar outstanding debt, or vice versa. The most common kind of bond used in the debt for bond swap is a callable bond because a bond must be called before swapping with another debt instrument. The bond's prospectus will detail the product's calling schedule.

Debt for bond swap transactions usually take place in order to take advantage of falling interest rates when the cost of borrowing goes down. Other reasons may include a change in the tax rates or for tax write-off purposes.

Understanding Debt for Bond Swaps

Debt for bond swap happens when a company, or individual, calls a previously issued bond, to exchange it for another debt instrument. Often, a debt for bond swap exchanges one bond for another bond with more favorable terms.

Bonds usually have strict rules concerning maturity and interest rates, so to operate within the regulations, companies issue callable bonds, which enable the issuer to recall a bond at any time without experiencing any penalties.

For example, if interest rates go up a company may decide to issue new bonds at a lower face value and retire its current debt that carries a higher face value; the company can then take the loss as a tax deduction.

Debt for Bond Swap and Callable Bonds

A callable bond is a debt instrument in which the issuer reserves the right to return the investor's principal and stop interest payments before the bond's maturity date. For example, the issuer may call a bond maturing in 2030 in 2020. A callable (or redeemable) bond is typically called at an amount slightly above par value. Higher call values are the result of earlier bond calling.

For example, if interest rates have declined since a bond's inception, the issuing company may wish to refinance the debt at the lower rate of interest. Calling the existing bond and reissuing will save the company money. In this case, the company will call its current bonds and reissue them at a lower interest rate. Corporate and municipal bonds are two types of callable bonds.

Generally, a debt for bond swap means issuing a second bond. A debt for bond swaps is most common when interest rates go down. Because of the inverse relationship between interest rates and the price of bonds, when interest rates go down a company can call the original bond with a higher interest rate, and swap it out with a newly issued bond with a lower interest rate.

Although a debt for bond swap does not require the issuance of a second bond, a company may choose to use another kind of debt instrument to replace the original bond. A debt instrument can be any paper or electronic obligation which enables an issuing party to raise funds by promising to repay a lender regarding a contract.

A debt for bond swap could replace the original bond with notes, certificates, mortgages, leases, or other agreements between a lender and a borrower.