Definition: A Bullet Bond (q.v.) that the bondholder can force the issuer to buy back at a scheduled price. The Put Price as a function of calendar time is the Put Schedule. A Bullet Bond plus a Put Option (q.v.) on the Bond. AKA Retractable Bond.
Example: A corporation might issue a ten-year Note (q.v.) with a five-year Put Option.
Application: A Putable Bond is a bet on the cost of refinancing at the Put Date. The issuer is betting that the Put Option will expire worthless – i.e., that interest rates will be low at the Put Date. The bondholder is betting that interest rates will rise, the bond price will fall, he will be able to sell the bond back to the issuer at a profit, and he will be able to reinvest the proceeds of that sale in a bond with a higher coupon.
Application: A Putable Bond is a bet on the cost of refinancing at the Put Date. The issuer is betting that the Put Option will expire worthless – i.e., that interest rates will be low at the Put Date. The bondholder is betting that interest rates will rise, the bond price will fall, he will be able to sell the bond back to the issuer at a profit, and he will be able to reinvest the proceeds of that sale in a bond with a higher coupon.
Pricing: You can price it as a bond, plus a put option on the bond. For it to sell near par requires a low coupon.
Risk Management: For example, suppose that a corporation issues a ten-year bond with an embedded five-year European Put Option. It is exposed to the danger of rising interest rates, in which case the bondholder will put the bond back to the issuer. However, if the issuer also buys a Payer Swaption, struck at the same coupon as the bond, then it will be able to issue floating rate debt to repay the principal on the bond and exercise the Swaption to continue paying the same fixed rate. The floating rate receipts from the Swaption will roughly cover the new floating rate debt interest.
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