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

Rating symbols, Rating Symbol Capacity ...

Rating Symbol Capacity for Timely Repayment Rating Symbol Capacity for Timely Repay

None, Reacher Technology has consulted with investment bankers and determin...

Reacher Technology has consulted with investment bankers and determined the intere Reacher Technology has consulted with investment bankers and determined the interest rate it woul

Cost of capital , ABC Ltd. Produces electronic components with a selling pr...

ABC Ltd. Produces electronic components with a selling price per of Rs.100. Fixed cost amount to Rs.2,00,000/- 5000 units are produced and sold each year. Annua

Equilibrium of an exchange economy, The economy consists of two consumers, ...

The economy consists of two consumers, A and B. Both consumers are endowed with one unit of good 1 and one unit of good 2. Consumer A is entirely indi?erent between all consumption

Define production limits used in practice to raise prices, How are producti...

How are production limits used in practice to raise the prices of the following goods or services: (a) taxi rides, (b) drinks in a restaurant or bar, (c) wheat or

What is business combinations, Q. What is Business Combinations? Combin...

Q. What is Business Combinations? Combining of two entities. Under PURCHASE METHOD OFACCOUNTING, one entity is deemed to attain another and there is a new basis of accountingfo

Portfolio management, Portfolio Management: Project Portfolio Manageme...

Portfolio Management: Project Portfolio Management (PPM) is the centralized management of processes, technologies and methods used by project management offices (PMOs) and pro

Define price ceiling make consumers better off, How can a price ceiling mak...

How can a price ceiling make consumers better off?  Under what conditions might it make them worse off? If the supply curve is completely inelastic a price ceiling will raise c

Describe the walters dividend model, Q. Describe the Walters dividend model...

Q. Describe the Walters dividend model? Walter's Model: - Walter's model maintains the doctrine that the dividend policy is relevant for the value of the firm. As-per to the Wa

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