Straight bonds are usually held till the maturity date for repayments of the principal amount. Depending on several factors, the investor may withdraw the money with bonds.
A Puttable or Put bond has the additional characteristic of having a put option with the bond. The Put option gives the investor the right to demand the investment before maturity.
How Do Puttable Bonds Work?
Investors look to receive coupons or interest on their investments in bonds. The issuers look for cash to fund their business needs. Bonds usually pay regular coupon payments at a determined interest rate.
The low bond yield may not attract investors, especially in a volatile economic market. The issuers attach an additional provision with the bond of a put option to attract investors.
A Put option attached to a bond offers flexibility to the investor to demand the principal investment back from the borrower before the maturity date.
As many investors look to trade the bonds in secondary markets, it also makes the bonds attractive and reselling security.
The repurchase price of the bond is usually set at Par or face value. However, both parties can agree before the bond purchase agreement is completed.
Other terms affecting the bond may also include the covenant of the Put option exercise date.
The borrower may add a clause barring the investor from exercising the Put option before a certain period. It usually happens if the bond has a long maturity date.
Why do Investors Exercise the Put Option?
In the first place, bonds are usually low-risk and low-reward investments. Investors look to trade the bonds in secondary markets to make profits.
Bonds with additional provisions, such as the Put option, offer greater flexibility and lure investors.
Any interest rate changes the bond’s supply and demand inversely. If the interest rates increase, it makes the existing bonds less attractive to investors.
The newer bonds will offer higher coupon payments than the existing ones. This Inverse interest rate relation plays an important role in secondary markets for bond trade.
In private markets, the investors may be able to secure Puttable bonds with lower yields and a discount issue price.
Even without a discount issue price, the Puttable bonds attract more investors in secondary markets due to the lower risk of price and default.
The Put option makes the bonds sell at a premium price than Face value. Private investors look to capitalize on quick gains with the premium price than low coupon yields.
Another situation may arise due to a default risk of the issuer. The investor may feel that the borrower will not be able to repay the amount by t maturity due to a weak financial position.
In that scenario, the Put option doesn’t attract other investors with a risky bond investment.
When investors look to exercise the Put option due to a change in the interest rate, the borrowers may offer a bond Swap to the investors.
If the investor demands the principal, the issuers offer them a similar value bond with new interest rates. The bond Swap fulfills the needs of both parties in the bond contract.
Advantages of the Puttable Bonds:
Puttable bonds offer lower yields to investors. But it also offers some advantages over straight bonds to the investors:
- Investors face less risk of default than a straight bond
- Puttable bonds offer extra security and a safe exit option to the investors
- A Put option with bonds makes them an attractive investment in secondary markets.
- Investors may add certain clauses in bond indentures to exercise the put option after a certain period or for certain conditions.
- The borrowers can acquire investments with lower coupon rates
- Borrowers may offer a bond Swap if the investors look to exercise the Put option.
A Puttable bond offers an incentive to both investors and issuers. Although it offers low yields, it attracts investors due to the less risky nature of the investment. The bond indenture may include specific clauses of terms that bind investors to hold the bond for a specific period.
The issuers may offer a specific one-time window to investors to exercise the Put option or several dates before the maturity.
The Put option is the only incentive to make this type of bond an attractive investment and sell at a premium price.
Can Bonds Be Transferred?
Bonds are financial instruments that can be exchanged or transferred between two parties. This type of exchange, known as the bond transfer, is common when an investor wants to liquidate his holdings and sell a bond before it matures.
Typically, the buyer must submit certain documents to the issuer for the transfer, such as proof of ownership and payment for the security.
When transferring bonds, there are certain rules that must be followed. Generally, both parties must agree to all terms involved in the transaction.
The buy-side must also have enough funds to purchase, while sellers may not have enough liquidity to complete the sale. Additionally, some exchanges may require permission from both parties or involve additional fees or taxes.
If bonds need to be transferred due to an inheritance or other special circumstances, additional paperwork or steps may be required.
Care should always be taken when transferring any bond because there are potential risks associated with each transaction.
Tax implications can also vary depending on who is involved and what type of security is being transferred.
Before conducting any transfers, it’s important for both buyers and sellers to understand all regulations associated with the specific bond they are dealing with, so they can avoid any unwanted consequences.
What Does Puttable Upon Death Mean?
Puttable upon death, commonly referred to as PUDs, is an important feature of certain bonds that grant the bondholder the right to redeem the security at face value on the death of the bond issuer. This option is typically extended to family members or individuals selected by the issuer and can be exercised if they hold it at the time of death. Generally, this type of option is only applicable when it’s stated in a prospectus.
The primary benefit of PUDs is that holders have access to their funds immediately after the bond issuer dies. This can be incredibly helpful for those with a large amount invested in a particular security who need some liquidity for near-term use. These put options can also help protect investors who may have purchased bonds at a premium price from taking a loss if something happens to the issuer before maturity.
It’s important to note that not all bonds offer this type of provision. Even then, there are usually additional stipulations associated with PUDs that must be understood before exercising them. Investors should always read through any prospectus closely and consult with financial advisors to ensure they understand all required terms and conditions before any transfer or negotiation takes place.