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

Final Project AFM, Ask questiona) Maju Construction (MCo) Sdn. Bhd. is bidd...

Ask questiona) Maju Construction (MCo) Sdn. Bhd. is bidding on a contract to build four tiny camping house (TCH) a year for the next three years for Sintokian campsite. Each TCH wi

Exchange Rate Parity Conditions, 1) According to the IFE (RIP), if U.S. inv...

1) According to the IFE (RIP), if U.S. investors expect a 3% rate of domestic inflation over one year, and a 6% rate of inflation in European countries that use the EUR, and requir

Partial correlation coefficients , In multiple correlation equations we are...

In multiple correlation equations we are often interested in finding out how much of the variation in the dependent variable is explained by one independent variable if all the oth

Capital Strructure., What is the rational for having different types of sec...

What is the rational for having different types of security

Evaluation of money-market hedge, Evaluation of money-market hedge Expe...

Evaluation of money-market hedge Expected receipt after 3 months = $300000 Dollar interest rate over three months = 5.4/ 4 = 1.35% Dollars to borrow now to have $300000 l

Explain the principles of taxation and double taxation, Question 1 ) A Glob...

Question 1 ) A Globalization is a procedure of international integration that arises due to increasing human connectivity as well as the interchange of products, ideas and other ph

Beta, what is the value of beta for this fund ? If the benchmark index for ...

what is the value of beta for this fund ? If the benchmark index for this mutual fund increased by 11.00% during the period covered by beta measure, what was the rate of return for

Define the conversion ratio and conversion value, Define the following term...

Define the following terms that relate to a convertible bond:  conversion ratio, conversion value, and straight bond value. The term conversion ratio is the number of shares of c

What are the limitations of trade payable day''s ratio, What are the Limita...

What are the Limitations oftrade payable day's ratio? Year-end trade payables may not be representative of the year. Credit purchases are VAT exclusive in the income sta

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