Components of a callable bond, Financial Management

Assignment Help:

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,

 


Related Discussions:- Components of a callable bond

Reinvestment risk, Reinvestment risk is the risk involved in reinvesting th...

Reinvestment risk is the risk involved in reinvesting the proceeds received from the issuer against callable bonds. During falling interest rate periods, investor canno

Explain speculator - market participants, Explain Speculator - Market Parti...

Explain Speculator - Market Participants A speculator attempts to profit from a modification in the futures price. For doing this, the speculator will take a long or short posi

Factors of importance of returns in any investment, Factors of Importance o...

Factors of Importance of returns in any investment Importance of returns in any investment decision can be traced to the following factors: It enables investors to

Contribution plans-pension fund plans, Defined Contribution Plans In de...

Defined Contribution Plans In defined contribution plans, the contributions made by or on behalf of the employee are accumulated and paid on retirement along with such return a

Explain the factors that are responsible for recent surge, What factors are...

What factors are responsible for the recent surge in international portfolio investment (IPI)? Answer:  The recent surge in international portfolio investments denotes the global

Financial leverage, Financial Leverage In accounting and finance, ...

Financial Leverage In accounting and finance, the amount of long lasting debt that an organization has in relation to its equity the longer the ratio, the larger the lever

Disadvantages of just-in-time inventory management, Q. Disadvantages of jus...

Q. Disadvantages of just-in-time inventory management? A JIT inventory management system mayn't run as smoothly in practice as theory may predict since there may be little room

Functions of derivatives market, Functions of Derivatives Market: To re...

Functions of Derivatives Market: To reduce risk or eliminate risks some ways and methods are there. Risk in the capital market can be reduced by diversification or putting eggs

Stock on tap, Stock on Tap: Most of the players who invest in these sec...

Stock on Tap: Most of the players who invest in these securities are institutions and hence the volumes are high. Considering that these securities are the first choice for ban

Traditional approach to valuation, Under this approach of Valuation, ...

Under this approach of Valuation, all cash flows are discounted using single interest rate (discount rate).  For example: Consider the 5-year (7.00 percent) Treas

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd