What Is a Put Bond?
A put bond is a debt instrument that allows the bondholder to force the issuer to repurchase the security at specified dates before maturity. The repurchase price is set at the time of issue and is usually at par value (the face value of the bond).
key takeaways
- A put bond is a debt instrument with an embedded option that gives bondholders the right to demand early repayment of the principal from the issuer.
- The embedded put option acts an incentive for investors to buy a bond that has a lower return.
- The put option on the bond can be exercised upon the occurrence of specified events or conditions or at a certain time or times.
How a Put Bond Works
A bond is a debt instrument that makes periodic interest payments, known as coupons, to investors. When the bond matures, the investors or lenders receive their principal investment valued at par. It is cost-effective for bond issuers to issue bonds with lower yields as this reduces their cost of borrowing. However, to encourage investors to accept a lower yield on a bond, an issuer might embed options that are advantageous to bond investors. One type of bond that is favorable to investors is the put, or puttable, bond.
A put bond is a bond with an embedded put option, giving bondholders the right, but not the obligation, to demand early repayment of the principal from the issuer or a third party acting as an agent for the issuer. The put option on the bond can be exercised upon the occurrence of specified events or conditions or at a certain time or times prior to maturity. In effect, bondholders have the option of "putting" bonds back to the issuer either once during the lifetime of the bond (known as a one-time put bond) or on several different dates.
Bondholders can exercise their options if interest rate levels in the markets increase. As there is an inverse relationship between interest rates and bond prices, when interest rates increase, the value of a bond decreases to reflect the fact that there are bonds in the market with higher coupon rates than what the investor is holding. In other words, the future value of coupon rates becomes less valuable in a rising interest rate environment. Issuers are forced to repurchase the bonds at par, and investors use the proceeds to buy a similar bond offering a higher yield, a process known as bond swap.
Of course, the special advantages of put bonds mean that some yield must be sacrificed. Investors are wiling to accept a lower yield on a put bond than the yield on a straight bond because of the value added by the put option. Likewise, the price of a put bond is always higher than the price of a straight bond. While a put bond allows the investor to redeem a long-term bond before maturity, the yield generally equals the one on short-term rather than long-term securities.
A put bond can also be called a puttable bond or a retraction bond.
Special Considerations for Put Bonds
The terms governing a bond and the terms governing the embedded put option, such as the dates the option can be exercised, are specified in the bond indenture at time of issuance. The bond may have put protection associated with it, which details the period of time during which the bond cannot be “put” to the issuer.
Some types of put bonds include the multi maturity bond, option tender bond, and variable rate demand obligation (VRDO).
FAQs
A put bond is a bond with an embedded put option, giving bondholders the right, but not the obligation, to demand early repayment of the principal from the issuer or a third party acting as an agent for the issuer.
What is a put option in a bond? ›
A bond option is a contract in which the underlying asset is a bond. A call option gives a holder the right to buy the bond at a specific price. A put option gives the holder the right to sell the bond at a specific price. Like all options, the contract holder is not obligated to exercise the option.
What is an example of a putable bond? ›
Puttable Bonds Example
For example, the State Bank of India issues a puttable bond for ₹1,00,000 with a 10-year term and 6% interest. If market rates rise to 8% after four years, reducing the bond's value, investors can exercise the put option to sell it back at ₹1,00,000.
What are the pros and cons of puttable bonds? ›
The advantage provided is that it contains an inherent price floor i.e. a price below which the market price of the bond will not fall in an event of an increase in market interest rate. This disadvantage is that this floor is not provided for free and the yield on a puttable bond is lower than for a conventional bond.
What is the difference between a call bond and a put bond? ›
A callable bond allows the issuer to repay it early, while a puttable bond permits the bondholder to sell it back before maturity. Callable bonds benefit issuers, while puttable bonds offer flexibility to bondholders.
What are the benefits of a putable bond? ›
Rising Interest Rates Protection → The notable advantage of a puttable bond is the protection offered against rising interest rates. If rates were to rise, the bondholder could force the sale of the bond back to the issuer and reinvest the proceeds at a higher interest rate.
How does a put option work for dummies? ›
A put option gives you the right, but not the obligation, to sell a stock at a specific price (known as the strike price) by a specific time — at the option's expiration. For this right, the put buyer pays the seller a sum of money called a premium.
How does a put bond work? ›
A put bond is a debt instrument that allows the bondholder to force the issuer to repurchase the security at specified dates before maturity. The repurchase price is set at the time of issue and is usually at par value (the face value of the bond).
Are putable bonds more expensive? ›
The value of a putable bond is usually higher than a straight bond as the owner pays a premium for the put feature.
How do you value a putable bond? ›
In the absence of default and interest rate volatility, the bond's future cash flows are certain. Thus, the value of a callable or putable bond can be calculated by discounting the bond's future cash flows at the appropriate one-period forward rates, taking into consideration the decision to exercise the option.
Similar to callable bonds, the rationale behind putable bonds is related to the inverse relationship between interest rates and the price of bonds. Since the value of the bonds declines as interest rates rise, they provide investors with protection from potential interest rate increases.
What is the formula for putable bond? ›
Value of putable bond = Value of straight bond + Value of investor put option. Value of investor put option = Value of putable bond – Value of straight bond.
What is the yield to worst for a puttable bond? ›
YTW is the lower of the yield to call or yield to maturity. 2 A put provision gives the investor the right to sell the bond back to the company at a certain price at a specified date. There is a yield to put, but this doesn't factor into the YTW because it is the investor's option on whether to sell the bond.
What is a bulldog bond? ›
A bulldog bond is a type of foreign bond issued by non-British corporations seeking to raise capital in pound-sterling from British investors. Bulldog bond is a bond, traded in the United Kingdom, that is purchased by buyers interested in earning a revenue stream from the British pound.
What is a mandatory put bond? ›
Put Bonds. This bond feature allows the investor to redeem the bonds typically at par value on a specific date prior to the bonds maturity date. Conversely, a mandatory put allows the issuer to call the bonds at a specified date prior to maturity whereas the investor cannot retain the bond.
What is a soft put bond? ›
" a bond with an embedded soft put is redeemable through the issuance of cash, subordinated notes, common stock, or any combination of theses three securities. In contrast, a bond with a hard put is only redeemable using cash.
What is put in bonds? ›
A put bond is a bond with an embedded put option, giving bondholders the right, but not the obligation, to demand early repayment of the principal from the issuer or a third party acting as an agent for the issuer.
What is an example of a put option? ›
On Jan 1, 2022, Nifty is at 16460. You buy a put option with strike price of 16500 at a premium of Rs 160 with expiry date Jan 27, 2022. A put option gives the buyer of the option the right, but not the obligation, to sell the underlying at the strike price. In this example, you can sell Nifty at 16500.
Why would you use a put option? ›
A put option becomes more valuable as the price of the underlying stock or security decreases. Conversely, a put option loses its value as the price of the underlying stock increases. As a result, they are typically used for hedging purposes or to speculate on downside price action.
What are the differences between an option on a bond and an option on a bond futures contract? ›
An option gives the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract. A futures contract obligates the buyer to purchase a specific asset, and the seller to sell and deliver that asset, at a specific future date.
