Putable bonus

economic-dictionary

A putable bond is a bond that carries an implicit right on the part of the holder to return the bond to the issuer on a predetermined date at a certain price called the resale price.

Putable bonds are usually bonds with a very long maturity. Thus, in order to place very long-term bonds and at the same time satisfy buyers, the issuer launches this type of bonds on the market.

Putable bonus example

Suppose a 20-year bond that is putable at par (100% of the par value) that can be sold at 5 years and with an interest rate of 7%. Suppose that after 5 years, the situation of the company worsens. The interest rates at which this company's bond is traded become 10%. The holder will sell the bonds since in the market they are paying, at that moment, a higher interest rate.

On the contrary, if the interest rate is reduced because the situation of the company improves, the holder will not exercise his right to sell the bond. In the event that the company improves its financial situation and offers 3% bonds, the holder will not sell his bond. They are paying you a much higher coupon (7%) instead of the 3% prevailing in the market on that date.

Why does a company issue putable bonds?

In the case of putable bonds, the advantage lies with the investor. He is the one who owns the option and, since he has the right to a certain date to sell the bonds, he can exercise that right. He will exercise this right if the conditions are favorable.

The reason why a company could issue this type of bond is to finance itself cheaper. That is, if as a company I give the investor advantages, to balance the balance, I will have to pay him less. The company saves financial costs. If a 5-year bond pays 3% per year, a putable bond is sure to pay less. In any case, it is very rare to see bond issues of this type. Silent bond issues are more likely to be found.

The convexity of putable bonds

The convexity of a putable bond is less than that of a normal bond as it approaches the set price or put price. For example, if a bond is bought at 100 and gives 5% per year, and the put price is 95. Anything that the price falls below 95 will not change the duration of the bond, therefore, the convexity will remain constant in that price. The duration will not fall, because it is assumed that the investor will exercise his option to sell the bond to the issuer when the price falls to 95. Since the price-performance ratio of a bond is inverse, I will obtain more returns if I sell the bond at fixed price and I buy bonds again. The duration (red dotted line) would be the duration of a bond with no option.

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