General Securities Sales Supervisor (Series10) Practice Exam

What must occur once a municipal bond issue is pre-refunded?

1. Bond must be called at any time

2. Old debt is retired at the call date

3. Investors must sell bonds back to the issuer

4. The call price must be renegotiated

The correct answer is: Old debt is retired at the call date

Once a municipal bond issue is pre-refunded, the old debt is retired at the call date. Pre-refunding refers to a process where an issuer sets aside funds, often from a new bond issue, specifically to pay off and retire the earlier bonds before their original maturity. This action typically occurs when interest rates decline, allowing issuers to lower their borrowing costs. When pre-refunding takes place, the funds are placed in an escrow account to cover the call price of the old bonds. As a result, when the call date arrives, the issuer uses the escrowed funds to pay off the existing bondholders. This effectively eliminates the old debt from the issuer's balance sheet and allows the issuer to benefit from potentially lower interest rates with the new bonds. The other options do not accurately reflect the mechanics of pre-refunding. For instance, the ability to call the bond at any time is not guaranteed; it is based on the bond's terms. Additionally, investors are not required to sell their bonds back to the issuer, nor is there typically a renegotiation of the call price involved. The structured nature of pre-refunding ensures that the original bondholders are paid the full amount as agreed upon at the specified call date, leading to a clean