Mandatory Redemption Schedule: What It Means, How It Works

Cierra Murry is a banking consultant, loan signing agent, and arbitrator with over 15 years of experience in financial analysis, underwriting, loan documentation, loan review, banking compliance, and credit risk management.

What Is a Mandatory Redemption Schedule?

A mandatory redemption schedule requires the issuer to set aside funds to redeem all or a portion of the outstanding bonds by scheduled dates prior to the maturity date.

Key Takeaways

• Mandatory redemption schedules mandate bond issuers to redeem outstanding bonds earlier than maturity.
• Mandatory redemption schedules can also require redemptions based on the available funds in the sinking fund.
• Bonds with mandatory redemption schedules have a smaller duration than bonds without redemption provisions.

Understanding Mandatory Redemption Schedules

A mandatory redemption schedule specifies the dates when the call provisions of the bond contract must be initiated. A call provision allows the issuer to redeem their bonds early at a set price. Redemption can be optional or mandatory. Bonds with mandatory redemption schedules have a smaller duration than similar bonds that cannot be redeemed prior to maturity.

With an optional redemption, the issuer has the option of buying back the bonds from investors on specified call dates listed in the trust indenture. Mandatory redemption is a call provision that requires the issuer to redeem bonds before their stated maturity date. Each term bond has its own mandatory redemption schedule in the original bond agreement.

Mandatory redemption schedules are useful for managing cash flows for mandatory calls. Some types of mandatory redemptions occur on a scheduled basis or when a specified amount of money is available in the sinking fund. The sinking fund is an annual reserve where the issuer makes periodic deposits to pay the costs of calling bonds in accordance with the mandatory redemption schedule or to purchase bonds in the open market. For example, a mandatory redemption schedule may require the issuer to redeem bonds ten years from the issue date.

Special Considerations

Bonds may be redeemed at a specified price, usually at par, and the bondholder will receive any accrued interest to the redemption date. Redemption can be full or partial. When a maturity of an issue is subject to partial redemption, the specific bonds to be redeemed may be selected in numerical order. Extraordinary events may trigger mandatory redemption. If an unusual circumstance affects the source of revenue used to service the debt, the issuer will be required to redeem the bonds.

For example, a revenue bond may be issued to fund an airport. The revenue generated from airport fees and taxes will be used to service the debt. However, if an adverse event occurs where the airport becomes inoperable, cash inflow will be nonexistent. In this case, the issuer will be unable to continue servicing the debt and may choose to trigger the extraordinary redemption clause.

For example, a revenue bond may be issued to fund an airport. The revenue generated from airport fees and taxes will be used to service the debt. However, if an adverse event occurs where the airport becomes inoperable, cash inflow will be nonexistent. In this case, the issuer will be unable to continue servicing the debt and may choose to trigger the extraordinary redemption clause.