Bonds with embedded put options, Financial Management

Assignment Help:

Put option is the right of the investor which he may exercise on the date at the put price given in the indenture. Normally, put price is in par value. When yield rises such that the bond's value falls below the put price, then investor will exercise the put option.

The value of putable bond is equal to the value of option-free bond plus the value of the put option. Therefore, the value of embedded option is equal to the difference between the value of a putable bond and the value of comparable option-free bond. 

Figure 1: Price/Yield Relationship for a Putable Bond and an Option-Free Bond

990_bond with embedded put options.png

Figure 1 shows that curve a - b' and a - a' shows the price/yield relationship of a putable bond and option-free bond respectively. When yield is lower than the coupon rate then price of the putable bond is same as option-free bond because the value of the put option is small. As interest rate increases the price of the putable bond declines but decrease in price is less when compared to that of option-free bond.  For a given yield level, the difference between the price of putable bond and comparable option-free bond is the value of a put option.


Related Discussions:- Bonds with embedded put options

Explain opportunity costs affect the capital budgeting, How do opportunity ...

How do opportunity costs affect the capital budgeting decision-making process? Opportunity costs imitate the foregone benefits of the alternative not chosen while a capital budge

Operating cycles, use the operating cycle to formulate a broiler business

use the operating cycle to formulate a broiler business

Stock exchange, Working and function of stock exchange

Working and function of stock exchange

Option-adjusted spread, The Option-Adjusted Spread (OAS) is a measu...

The Option-Adjusted Spread (OAS) is a measure of the yield spread (expressed in basis points) which can be used to convert differences between the values an

Sales of the firm, The financial ratios of a firm are given:     Current ra...

The financial ratios of a firm are given:     Current ratio    =  1.33   Acid-test ratio   =  0.80   Current liabilities  = 40,000   Inventory turnover ratio = 6    What is the

Define u.s. dollar and the canadian dollar, Under what circumstance would t...

Under what circumstance would the U.S. dollar and the Canadian dollar be said to have achieved purchasing power parity? The U.S. dollar and the Canadian dollar would be referred

Agency relationships, explain the relationship between shareholders and cre...

explain the relationship between shareholders and creditors

Calculate the price of winnebago stock , Calculate the price of Winnebago s...

Calculate the price of Winnebago stock (Winnebago has no debt so this is the market value of the firm seperated by the number of common shares outstanding.) from the cashflows you

Define insurance company that takes on the greater risks, Which type of ins...

Which type of insurance company generally takes on the greater risks: a life insurance company or a property and casualty insurance company? The risks protected in opposition to

Define depreciation expense, Define depreciation expense as it appears on t...

Define depreciation expense as it appears on the income statement. How does depreciation affect cash flow? The term accounting depreciation is the allocation of an asset's init

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