What Is a Mandatory Redemption Schedule?

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

Key Takeaways

  • Mandatory redemption schedules mandate a bond issuer to redeem all or part of the outstanding bonds by the scheduled dates earlier than its maturity.
  • A mandatory redemption schedule can also specify that redemptions must happen based on the amount of money available in the sinking fund.
  • Bonds with mandatory redemption schedules have a smaller duration than bonds that cannot be redeemed prior to maturity.

Understanding Mandatory Redemption Schedules

The mandatory redemption schedule states the specified dates when the call, or prepayment, provisions of the bond contract must be initiated. A call provision allows the issuer to redeem their bonds early at a set price. Redemption of a bond can be optional or mandatory. A bond with a mandatory redemption schedule has a smaller duration than a bond, with a similar maturity, that cannot be redeemed prior to maturity, like a bullet bond.

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 an issuer to redeem bonds before their stated maturity date. Each term bond has its own mandatory redemption schedule set out in the original bond agreement.

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

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 could either be full or partial. Where a particular maturity of an issue is subject to partial redemption, the specific bonds to be redeemed may be selected by lot in numerical order. Extraordinary events may trigger mandatory redemption. In the event that an unusual circumstance occurs which 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 in which 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.