What Is Doubling Option?
A doubling option is a provision in a sinking fund that gives a bond issuer the right to redeem twice the amount of debt when repurchasing callable bonds. A doubling option allows the issuer to retire additional bonds at the sinking fund's call price.
- A doubling option is a sinking fund provision that gives a bond issuer the right to redeem twice the amount of debt when repurchasing callable bonds.
- A doubling option allows the issuer to retire additional bonds at the sinking fund's call price.
- A doubling option will usually be exercised by the bond issuer as current interest rates move lower than the bond's yield.
Understanding Doubling Option
A doubling option is a provision included in some bond indentures, or legal agreements. It is related to the bond indenture's sinking fund provision. A sinking fund provision is a stipulation included in many bond indentures that requires the bond issuer to set aside a certain proportion of money each year into a fund or account in order to repay bondholders at maturity.
A sinking fund can add safety to a corporate bond issue. That's because the bond issuer is less likely to default on the repayment of the remaining principal upon maturity, since the amount of the final repayment will be substantially lower. Bonds with sinking funds typically provide downside protection as well as a lower risk of default. For this reason, they often offer lower yields than bonds without sinking funds.
A doubling option gives the bond issuer the right to double the sinking fund provision. In other words, the issuer can repurchase as much as two times as many bonds as are specified in the sinking fund provision. The bonds for repurchase are typically selected by lottery, and the repurchase will typically happen at the bond's par value.
A doubling option will usually be exercised by the bond issuer as current interest rates move lower than the bond's yield. In this circumstance, the bond issuer may be motivated to repurchase more debt through the sinking fund option and refinance itself at the new, lower rates. For this reason, exercising the doubling option reduces the return that investors will receive.
Example of a Doubling Option
A doubling option works as follows. Imagine that a company issues $1 million worth of bonds that are set to reach maturity in 20 years. The bonds issued have a sinking fund provision, which requires the company to set aside $50,000 into a sinking fund each year for 20 years. The sinking fund provision also requires the bond issuer to use those funds to retire a portion of the debt each year by repurchasing bonds on the open market. If the bond issue also has a doubling option, the bond issuer may opt to redeem up to $100,000 worth of bond issue per year.