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What Is a Debt for Bond Swap?

Osmand Vitez
Osmand Vitez

A debt for bond swap occurs when a company calls in a previously issued bond and exchanges it for another debt instrument. In some cases, the swap may essentially be one bond for another bond, with the new debt instrument being more favorable in terms for the issuer. A common reason a company engages in a debt for bond swap is to take advantage of changes in the interest rates for debt investments. Other times, changes to tax rates may be a reason for this swap of debt instruments. Large companies or organizations are the most common users of this process as they are the entities most likely to issue bonds.

Callable bonds are most likely necessary for a company to engage in a debt for bond swap. Bonds typically have strict rules in terms of purchase price, interest rate, and time allowed until bond maturity. In order to not violate any of these standards, a company issues a callable bond where the purchase agreement between the issuer and buyer says the issuer can recall the bond at any time without penalty. The agreement may indicate the buyer will receive a second bond or slightly higher compensation than normal if the issuer calls in this initial bond. Each bond has its own rules in this way, making some callable and others not callable.

Man climbing a rope
Man climbing a rope

The debt for bond swap most likely involves the issuance of a second bond. Companies often issue these debt instruments because they need money for long-term projects. Therefore, calling in bonds early does not make sense as the company would need to repay investors the entire bond price plus whatever interest goes with it. The debt for bond swap works better if interest rates go down, meaning the company can call in a previous bond with a higher interest rate and issue a new bond at the lower interest rate. When this occurs, the project associated with the bond costs less money, making the project more profitable in the long run.

A reverse debt for bond swap may also be possible in the business market. For example, a company may call a bond in early and repay investors. Rather than issue another bond, the company or other entity can obtain a traditional loan through a bank. This swap may have different benefits, such as tax or balance sheet benefits that make the company stronger in the long term. Either way, a defined benefit is usually at the source for this swap.

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