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

Define the General principles of the city code General principles of the city code Information available to all shareholders and shoul

Along with the fixed capital nearly every Small-Scale industries requires working capital though the extent of working capital requirement differs in different businesses. Working

Ashok is to receive an amount of Rs. 15,00,000 from his relative after 3 years. He wants to buy a house for which he wants the money to be paid now. His relative had al

credit limit decision bajaj electronics company

Q. Equity Method of Accounting? Equity Method of Accounting - Investors cost basis is adjusted up or down (according to the % of stock ownership) as investee's retained earning

Based on the period involved in repayment of the debt obligations, the debt instruments could be classified into long-/medium-/short-term debt instruments.


Functions of a Stock Exchange The stock exchange is a market place where investors trade in securities. It is a competitive market involving large numbers of buyers and sellers

I need assistance on Cost of preference share capital in financial management? Can someone help me to solve this proble with example It's Urgent!!!!!!!