Mathematical Finance & Financial Data Science Seminar
After-tax valuation of callable bonds
Speaker: Andrew Kalotay, Kalotay Advisors
Location: Online Zoom access provided to registrants
Date: Tuesday, April 18, 2023, 5:30 p.m.
The call option is a prevalent feature of both corporate bonds and tax-exempt (muni) bonds. Virtually every muni is callable at par after 10 years. Issuers compensate the investors for the call option by paying a higher coupon or by accepting a lower price, relative to a like optionless bond.
Asymmetrical tax treatment is typical. Corporations deduct the interest paid on their bonds, which are usually held in non-taxable accounts. Municipalities don’t pay tax, while muni investors are always taxable.
Suppose the market is indifferent between fairly priced callable and non-callable bonds. From the perspective of the issuer, due to the above-mentioned tax asymmetry, one of these bonds may be preferable. It turns out that the call option is desirable for corporate bonds, because the expected savings from refinancing exceed the cost of the option. But in the case of munis, the cost of the option exceeds the expected savings; optionless muni bonds would be preferable to callables.
Andrew Kalotay is an expert on the quantitative analysis of municipal bonds, including risk management, tax management, and debt management. He is a prolific contributor to both the academic and practitioner literature, including the book ‘The Interest Rate Risk Management of Municipal Bonds’.
He founded Andrew Kalotay Associates in 1990, and sold it to the Intercontinental Exchange in 2021. His firm provided bond analytics to some of the most sophisticated market participants. Previously he was with Salomon Brothers, and prior to Wall Street, he was at Bell Laboratories and AT&T.
On the academic side, he directed the first graduate Financial Engineering program in the U.S. at Polytechnic University (now part of NYU), from 1995 to 1997. Previously he taught at Wharton, Columbia, and Fordham University.
Dr. Kalotay holds a B.Sc. and M.Sc. from Queen's University and a Ph.D. from the University of Toronto, all in mathematics. He was inducted into the Fixed Income Analyst Society’s "Hall of Fame" in 1997.