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

State the term nature of financial instruments, State the term nature of fi...

State the term nature of financial instruments. Nature of financial instruments (securities): Financial instruments (termed as securities) can be classifies in two broad

Illustrate the nature of financial management, Q. Illustrate the Nature of ...

Q. Illustrate the Nature of Financial Management? Less Descriptive as well as More Analytical: - Financial management is less descriptive and more analytical. Because of the

Participants in hedge funds-management company, The Manager or Management C...

The Manager or Management Company The firm sponsoring the Fund could often structure it as a management company. Its primary responsibility is to determine investment strategie

Shareholders'' wealth maximization, Shareholders' wealth maximization S...

Shareholders' wealth maximization Shareholders' wealth maximization refers to maximization of the net present value of every decision made in the firm. Total present value is e

Example to show the companys current gearing, Q. Example to show the compan...

Q. Example to show the companys current gearing? The company's current gearing 2000/ 8500 × 100 = 23.53% The current gearing position is on the low side particularly wh

Calculate total amount of dividends in arrears, QTL Tech has an issue of pr...

QTL Tech has an issue of preferred shares outstanding with a $50 stated value that pays a dividend of 7.5%. There are 325,000 shares outstanding. QTL has not paid preferred share d

State the term - redemption, State the term - Redemption Redemption is ...

State the term - Redemption Redemption is repayment of debt security at or before maturity.  Redemption could at par or at a premium to face value. A debt security will be rede

Strong form level of efficiency, Strong form level of Efficiency This l...

Strong form level of Efficiency This level states that price reflects all the available public and private information (past, present and future information). If the hypothesis

Explain demerits of accept-reject criteria, Q. Explain demerits of accept-r...

Q. Explain demerits of accept-reject criteria? Demerits of ARR:- (i) It utilizes accounting income rather than cash flows: - The principal short coming of ARR schema is th

Tax-backed debt, An analyst should first examine the issuers ...

An analyst should first examine the issuers debt structure in order to analyze the tax-backed debts. The debt burden consists of respective direct a

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