Module 36.1 LOS 36.b Explain the relationships between the values of a callable or putable bond, the underlying option-free (straight) bond, and the embedded option

We can view the holder of a callable bond as owning a straight bond and holding a short a call option on the bond. The value of the embedded call option (Vcall) is the difference between the value of a straight (Vstraight) bond and the value of the comparable callable bond (Vcallable):

Vcall = Vstraight − Vcallable

Conversely, investors are willing to pay a premium for a putable bond, since its holder effectively owns an option-free bond plus a put option. The value of a putable bond can be expressed as:

Vputable = Vstraight + Vput

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