Understanding Yield-Maintenance Agreements

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A yield-maintenance agreement is a type of agreement between a bond issuer and a bondholder that allows the issuer to repurchase the bonds before maturity. In this agreement, the issuer agrees to pay the bondholder the present value of the remaining cash flows on the bonds, plus an additional amount to compensate the bondholder for the loss of yield that they would have received if the bonds had been held to maturity.

In a yield-maintenance agreement, the securities repurchased may have a different stated interest rate from that of the securities sold and are generally priced to result in substantially the same yield. This means that the repurchased securities may have a different coupon rate or stated interest rate than the original securities sold, but the yield or overall return on the repurchased securities will be similar to the yield on the original securities sold.

For example, let's say that an issuer sold bonds with a 5% coupon rate to a bondholder. After a year, the issuer wants to repurchase the bonds before maturity. The bondholder agrees to sell the bonds back to the issuer under a yield-maintenance agreement. The issuer may repurchase the bonds with a different coupon rate, say 4%, but will pay the bondholder an additional amount to compensate for the lost yield.

The key feature of a yield-maintenance agreement is that it is designed to compensate the bondholder for the lost yield that they would have received if the bonds had been held to maturity. This ensures that the bondholder is not disadvantaged by the early repurchase of the bonds.