Quizmaster, Doug Hutchinson, presents his quiz for the month. Here, Doug discusses the complexities of bond tender offers.
Consider this Scenario:
Your friend Patricia has received tender offers on two bonds that she owns.
A tender offer is a formal offer to buy bonds from the current holders at a specified price.
Bond #1: She owns $100,000 of a corporate bond paying a 5% coupon maturing in January 2020. The tender offer is 104. This bond is not callable and is currently trading at about 104.50.
Bond #2: She owns $100,000 of a corporate bond paying a 4% coupon maturing September 2019. The tender offer is at +260 basis points over the yield of the 2-year Treasury. Assume that the yield on the 2-Year Treasury is 1.40%. The bond is currently trading at about 98.
Which of these options would probably make the most sense for Patricia?
a. Accept the tender offer for both bonds
b. Don’t accept the tender offer for either bond
c. Accept the tender offer for Bond #1 but not Bond #2
d. Accept the tender offer for Bond #2 but not Bond #1
Solution:
There is not always a clear-cut right or wrong answer on the question of whether to accept a tender offer because there are many different factors to consider. That said, the most important factor to consider is whether the tender offer is above the market price of the bond.
For Bond #1:
A tender offer of 104 means that it would be worth $104,000 ($100,000 x 104% = $104,000). The bond is currently trading at 104.50 so she could get $104,500 ($100,000 x 104.5% = $104,500) if she were to sell in the open market. It doesn’t make much sense to accept a tender offer below the market price of a bond. She should probably decline to participate in the tender offer for this bond.
For Bond #2:
A tender offer of +260 basis points over the 2-year Treasury yielding 1.40% means the tender offer will be at a 4% yield. A 4% coupon bond with a 4% yield would mean that the tender offer would be at 100. The bonds are currently trading at 98. So accepting the tender offer would mean that she would receive $100,000 for the tender offer versus $98,000 ($100,000 x98% = $98,000) she could get by selling in the market. Because the tender offer is at a premium to the market value, she could accept the tender offer and then use the proceeds to buy a similar bond with a better yield. She should probably accept the tender offer for this bond.
The best answer is D: Accept the tender offer for Bond #2 but not Bond #1
There are many factors to consider in deciding whether to accept a tender offer including whether the tender offer is above the market price, whether you can find a comparable bond if you accept the tender offer and want to redeploy the funds, whether the bond is callable in the future, and whether there are liquidity or credit concerns with the bond in question. Patricia should consider working with a financial professional to help her make these types of decisions.
The financial advisors at WrapManager can provide expert advice accepting bond offers. Give them a call at 1-800-541-7774 or contact us here to get in touch with a Wealth Manager today.
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