Callable Bonds
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Callable and Putable Bonds: Vocabulary and Optimal Exercise, Study notes of Investment Theory
Vocabulary definitions and optimal exercise strategies for callable and putable bonds. Callable bonds allow issuers to repay the debt earlier, while putable bonds enable purchasers to collect the debt earlier. European, Bermudan, and American options, lockout periods, and yield optimization for bonds bought at a discount or premium.
What you will learn
- What is the difference between callable and putable bonds?
- What are the European, Bermudan, and American options for callable bonds?
- How does the optimal exercise strategy differ for callable bonds bought at a discount versus a premium?
Typology: Study notes
2021/2022
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Callable Bonds
Vocabulary
- (^) Callable bonds are issued with a call provision that allows the issuer to repay the debt earlier, i.e., before maturity
- (^) The dates at which the debt can be repaid early are called call dates and for each of them, a particular redemption value is specified
- (^) The initial period before the first call date is called the lockout period
- (^) European option... single call date before maturity
- (^) Bermudan option... multiple (discrete) call dates before maturity
- American option... all dates before maturity are call dates
Vocabulary
- (^) Callable bonds are issued with a call provision that allows the issuer to repay the debt earlier, i.e., before maturity
- (^) The dates at which the debt can be repaid early are called call dates and for each of them, a particular redemption value is specified
- (^) The initial period before the first call date is called the lockout period
- (^) European option... single call date before maturity
- (^) Bermudan option... multiple (discrete) call dates before maturity
- American option... all dates before maturity are call dates
Vocabulary
- (^) Callable bonds are issued with a call provision that allows the issuer to repay the debt earlier, i.e., before maturity
- (^) The dates at which the debt can be repaid early are called call dates and for each of them, a particular redemption value is specified
- (^) The initial period before the first call date is called the lockout period
- (^) European option... single call date before maturity
- (^) Bermudan option... multiple (discrete) call dates before maturity
- American option... all dates before maturity are call dates
Optimal exercise
- (^) At a discount: If a bond is bought at a discount and it has a Bermudan option with call dates at coupon dates and redemption amount C independent of the time it is called, then the smallest yield occurs if the bond is not called before maturity
- At a premium: If a bond is bought at a premium and it has a Bermudan option with call dates at coupon dates and redemption amount C independent of the time it is called, then the smallest yield occurs if the bond is called at the earliest call date
Optimal exercise
- (^) At a discount: If a bond is bought at a discount and it has a Bermudan option with call dates at coupon dates and redemption amount C independent of the time it is called, then the smallest yield occurs if the bond is not called before maturity
- • At a premium: If a bond is bought at a premium and it has a Bermudan option with call dates at coupon dates and redemption amount C independent of the time it is called, then the smallest yield occurs if the bond is called at the earliest call date
Putable bonds
- (^) Putable bonds are issued with a put provision that allows the purchaser of the bond to to collect the debt earlier, i.e., before maturity
- (^) Additional terminology and conventions apply in analogy to the callable bonds