The Timing of Refunding

In addition to cash flows resulting from an immediate refunding, firms must consider the possibility of waiting to refund on potentially better terms. To clarify this point, consider the courses of action to the firm at time t as shown in Figure 12.2. At time t, the firm can either refund and realize a net refunding benefit of B_t or wait. If the firm refunds at time t, it cannot refund this same bond again. If the choice at time t is to wait, then, at time t + 1, the choices are to wait or to refund for a benefit of B_t+1, which may be greater than, equal to, or less than B_t. However, by waiting, the firm continues to pay the old coupon, a cost of waiting. Thus, waiting may result in an additional benefit, no change, or a reduced benefit. The same scenario applies for waiting and refunding at later points in time. Because waiting and refunding in the future may result in a greater refunding benefit, the call option may have some value beyond the current intrinsic value of refunding immediately.