Components of a callable bond, Financial Management

Components of a Callable Bond

A callable bond can be thought of as the sale of a call option by the investor to the issuer as it allows the issuer to repurchase the bond from the time it becomes callable until the maturity date. The purchaser of a callable bond effectively enters into two transactions.

  • Purchase of a non-callable bond for which they pay some price.
  • Sale of a call option to the issuer for which they receive the option price from him.
  • The net price paid by callable bondholder is given by,
  • Price of the callable bond = Price of the non-callable bond - Price of the call option.

The difference between the price of the non-callable bond and the callable bond is the price of the embedded call option. Though we have simplified the situation for explanatory purposes, in practice it is not easy to define the price of a callable bond like this. The issuer may call the bond at the first call date or any time thereafter or any subsequent coupon anniversary. Thus the investor has sold a strip of call options to the issuer. The price of the call option may vary with the date the option is exercised by the issuer. But it is always easier to describe the investor's position as a combination of a long position in non-callable bond and a short call option.

Components of a Puttable Bond

In the case of a puttable bond, the investor acquires a right to exercise his option at a predetermined price and time. Thus a puttable bond can also be described as involving two transactions.

  • Purchase of a non-puttable bond;
  • Purchase of a put option on the bond.

The put option allows the investor to sell the bond to the issuer. An investor will exercise the put option when the market yield is greater than the coupon rate on the bond. The price of the puttable bond is given by,

 

Posted Date: 9/10/2012 8:13:35 AM | Location : United States







Related Discussions:- Components of a callable bond, Assignment Help, Ask Question on Components of a callable bond, Get Answer, Expert's Help, Components of a callable bond Discussions

Write discussion on Components of a callable bond
Your posts are moderated
Related Questions
Why is it important to study international financial management? Answer:  We are now living in a world in which all the main economic functions, that are production, consumption,

Changes in the bond value is inversely related to the change in the interest rates. If an investor holds a long bond position, he would incur loss if the in

Brandon Michael Chu of Henry Law & Yang Yi Capital Limited believes that earnings and dividends at Alua Amanova & Shuwen Wang Technologies (AST) will continue to grow at 12% per ye

Q. Function of the Investment decision? Investment decision related of the selection of the fixed assets. the assets can be acquired fall into two board groups i) long terms

Chain Index Numbers So far, we have constructed index numbers with a fixed base. Sometimes, comparison between the current/given year and the base year becomes meaningless once

Q. Explain Compound Value Concept? The Compound Value Concept is used to find out the FV of present money. It is the same as the concept of compound interest, wherein the inter

Divestment of company re-organisations Adisinvestment or divestment is selling part of the business or subsidiary to another third party. Reasons and features for divestme

Wing Yin Tsui, CEO of Lian Huang & Wong Bin Dean Hwang Manufacturing Limited is considering a four year project. The project requires an initial investment of $10,000,000 to buy ne

Profitability Ratios   Profit Margin  It is a measure of the profit margin of the company. This is important to gauge the financial position of the company.

Define depreciation expense as it appears on the income statement. How does depreciation affect cash flow? The term accounting depreciation is the allocation of an asset's init