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By issuing numerous callable bonds, they have a natural hedge, as they can then call their own issues and refinance at a lower rate. The price behaviour of a callable bond is the opposite of that of puttable bond. Since call option and put option are not mutually exclusive, a bond may have both options embedded. [3]
Fully Callable Bonds. Can be called at any time after the call date if applicable. Common among corporate bonds. Partially Callable Bonds. Only a portion of the bond can be called, not the full amount
Other common pricing-methods are simulation and PDEs. Option-adjusted spread (OAS) is the yield spread which has to be added to a benchmark yield curve to discount a security's payments to match its market price, using a dynamic pricing model that accounts for embedded options. OAS is hence model-dependent.
Yield to put (YTP): same as yield to call, but when the bond holder has the option to sell the bond back to the issuer at a fixed price on specified date. Yield to worst (YTW): when a bond is callable, puttable, exchangeable, or has other features, the yield to worst is the lowest yield of yield to maturity, yield to call, yield to put, and others.
Types of bonds more likely to be affected by reinvestment risk: Callable bonds, short-term bonds, zero-coupon bonds, mortgage-backed securities and asset-backed securities. 4. Liquidity risk
Securities other than bonds that may have embedded options include senior equity, convertible preferred stock and exchangeable preferred stock. See Convertible security. [citation needed] The valuation of these securities couples bond-or equity-valuation, as appropriate, with option pricing. For bonds here, there are two main approaches, as ...
Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. These are called callable bonds. [10] A less common feature is an embedded put option that allows investors to put the bond back to the issuer before its maturity date. These are called putable bonds.
Therefore, if interest rates fall and bond prices rise, a firm will benefit from the sinking fund provision that enables it to repurchase its bonds at below-market prices. In this case, the firm's gain is the bondholder's loss – thus callable bonds will typically be issued at a higher coupon rate, reflecting the value of the option.