Putable Bond - Definition, How It Works, and How to Value 13/09/2023, 18:12

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Putable Bond
A bond that provides the holder (investor) the right but not the obligation to
force the issuer to redeem the bond before its maturity

Written by CFI Team

What is a Putable Bond?

A putable bond (put bond or retractable bond) is a type of bond that provides
the holder of a bond (investor) the right, but not the obligation, to force the
issuer to redeem the bond before its maturity date. In other words, it is a bond
with an embedded put option. Putable bonds are directly opposite to callable
bonds.

If the embedded put option is exercised, the bondholder receives the principal
value of the bond at par value. In certain cases, the bonds can be retracted as a
result of extraordinary events. However, more frequently, the embedded put
option can be exercised after a predetermined date.

How are put options important to investors and

issuers?
Similar to callable bonds, the rationale behind putable bonds is related to the
inverse relationship between interest rates and the price of bonds. Since the
value of the bonds declines as interest rates rise, they provide investors with
protection from potential interest rate increases.

At the same time, the bond issuers reduce their cost of debt by providing lower

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Putable Bond - Definition, How It Works, and How to Value 13/09/2023, 18:12

yields on the bonds. Investors accept lower yields in exchange for the
opportunity to exit the investments in case of unfavorable market conditions.

How do putable bonds work?

Let’s consider the following example to understand how these bonds work:

ABC Corp. issues putable bonds with a face value of $100 and a coupon rate
4.75%. The current interest rate is 4%. The bonds will mature in 10 years.

The put option provides investors with the right to force ABC to redeem the
bonds after the "rst "ve years.

If, after the "rst "ve years of the bonds’ life, interest rates have signi"cantly
increased, the investors do not have an incentive to keep the bonds until
maturity. Rather than holding the bonds to maturity, they can exercise the
embedded put option and receive the principal amount of their initial
investment. They can then use the proceeds to invest in newly issued bonds
with a higher coupon (interest) rate.

However, if interest rates remain the same or decline, the investors do not have
an incentive to exercise the put option. They will likely hold the bonds until
maturity. In such a scenario, both parties will enjoy the same payo# as in plain-
vanilla bonds.

Note that the coupon rate of putable bonds may be slightly lower than that of
plain-vanilla bonds. This is to compensate the issuer for the additional risk of
investors exercising the put option.

How to !nd the value of a putable bond?

Valuing putable bonds di#ers from valuing plain-vanilla bonds because of the
embedded put option. Since the option provides investors with the right to
force the issuers to redeem the bonds, the put option a#ects the price of a
(putable) bond.

The fair market price of a (putable) bond can be found using the following
formula:

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Putable Bond - Definition, How It Works, and How to Value 13/09/2023, 18:12

Where:

Price (Plain – Vanilla Bond) – the price of a plain-vanilla bond that shares
similar features with a (putable) bond.

Price (Put Option) – the price of a put option to redeem the bond prior to
maturity.

Additional resources
CFI is the o$cial provider of the global Financial Modeling & Valuation Analyst
(FMVA)! certi"cation program, designed to help anyone become a world-class
"nancial analyst. To keep learning and advancing your career, the additional
resources below will be useful:

Margin Trading

Options: Calls and Puts

Rate of Return

Speculation

See all !xed income resources

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