Optimum Bond Calling and Refunding

Long-term corporate bonds have traditionally been issued with a call option, whereby the issuing company reserves the right to call the bond, that is, to redeem or buy back the bond prior to maturity. Usually the purpose of calling the bond is to be able to refund it, that is, replace it with one having a lower interest rate, or coupon. During 1976–77, when interest rates had dropped significantly from the rates of 1969–70 and 1974–75, Bell System companies called or refunded over $2 billion of long-term debt. This paper describes how analytical techniques developed at Bell Labs and AT&T played a significant role in these refundings.