Yield Maintenance

Yield maintenance is a provision in a bond indenture that requires the issuer to make periodic payments to the bondholders to ensure that the yield on the bonds remains at a specified level. This can be done by making payments of principal or interest, or by issuing additional bonds.

Yield maintenance is often used in bond issues with floating interest rates, as it protects the bondholders from the risk of rising interest rates. For example, if a bond is issued with a floating interest rate of LIBOR + 2%, the yield maintenance provision would require the issuer to make payments to the bondholders if LIBOR rises above 2%. This would ensure that the bondholders continue to receive a yield of 2%, even if LIBOR rises.

Yield maintenance can also be used in bond issues with fixed interest rates. For example, if a bond is issued with a fixed interest rate of 5%, the yield maintenance provision would require the issuer to make payments to the bondholders if the bond's credit rating is downgraded. This would ensure that the bondholders continue to receive a yield of 5%, even if the bond's credit rating is downgraded.

Yield maintenance can be a valuable tool for bondholders, as it protects them from the risk of rising interest rates or a downgrade in the bond's credit rating. However, it can also be a costly provision for issuers, as it can require them to make payments to the bondholders even if they are not profitable.

Here are some additional details about yield maintenance:

• Yield maintenance is typically used in bond issues with a term of more than five years.
• The yield maintenance provision is typically set at a level that is slightly higher than the bond's coupon rate.
• The yield maintenance provision can be structured in a variety of ways, but it typically involves the issuer making periodic payments to the bondholders.
• The yield maintenance provision can be triggered by a variety of events, such as a rise in interest rates, a downgrade in the bond's credit rating, or a default on the bond's principal or interest payments.

Yield maintenance is a complex financial concept, and it is important to understand the implications of this provision before investing in a bond issue that includes it.