Putable Bond
What Is a Putable Bond?
A putable bond (or put bond) is a bond that gives the bondholder the right (but not the obligation) to force the issuer to repurchase the bond at a specified price (usually par) before the maturity date.
A putable bond is a bond with an escape hatch for the investor. Standard bonds lock your money away until maturity. If interest rates rise, the value of your standard bond crashes, and you are stuck earning a low rate while the rest of the market pays more. With a putable bond, if interest rates rise, you can exercise your option to sell the bond back to the issuer at face value (e.g., $1,000). You get your principal back immediately and can reinvest it at the new, higher interest rates. Because this feature is valuable insurance for the investor, the issuer pays a lower interest rate (coupon) on the bond. The investor accepts a lower yield in exchange for protection against rate hikes.
Key Takeaways
- It includes an embedded put option for the investor.
- The investor can "put" (sell) the bond back to the issuer early.
- This feature protects the investor against rising interest rates.
- Because it benefits the investor, putable bonds offer lower yields (coupons) than standard bonds.
- It is the opposite of a "Callable Bond" (which benefits the issuer).
- Often used in municipal bonds or corporate debt.
How It Works: The Put Option
1. **Issuance:** Company X issues a 10-year bond paying 4% with a "put option" exercisable after 5 years. 2. **Scenario A (Rates Fall):** Market rates drop to 2%. The 4% bond is valuable. The investor holds the bond or sells it at a premium. The put option is ignored. 3. **Scenario B (Rates Rise):** Market rates jump to 6%. A standard 4% bond would drop in price to ~$850. However, the investor exercises the put option. 4. **Exercise:** The issuer must buy the bond back at $1,000. 5. **Reinvestment:** The investor takes the $1,000 and buys a new bond paying 6%.
Putable vs. Callable Bonds
Comparison of embedded options.
| Feature | Putable Bond | Callable Bond | Winner |
|---|---|---|---|
| Option Holder | Investor | Issuer | Who decides? |
| Benefit | Protects against rising rates | Protects against falling rates | Risk Hedge |
| Yield | Lower than standard | Higher than standard | Cost of Option |
| Price Behavior | Price floor at Par | Price ceiling at Call Price | Volatility |
The Bottom Line
The putable bond is a defensive instrument. Putable bond is a debt security with an early exit. Through granting the holder the right to redeem, it eliminates the interest rate risk inherent in long-term bonds. For investors who fear inflation or Fed rate hikes, putable bonds offer peace of mind, albeit at the cost of lower income today. They are essentially a bond plus a long put option on bond prices.
FAQs
It depends on the bond's indenture (contract). Some have a single put date (one-time put), while others have multiple dates (e.g., every year on the anniversary of issuance).
To save on interest costs. Because the investor values the put option, they accept a lower coupon rate. This lowers the issuer's cost of borrowing, provided rates don't rise significantly.
Usually Par Value (100% of face value). This ensures you get your principal back.
They still carry credit risk (the issuer could go bankrupt and be unable to buy the bond back). However, they have much lower interest rate risk than standard bonds.
The Bottom Line
Investors looking to hedge against interest rate risk may consider putable bonds. Putable bond is a bond with a floor. Through allowing investors to force redemption, it protects principal value when rates rise. While rare in the corporate market compared to callable bonds, they are a powerful tool for conservative fixed-income portfolios. They ensure that if the economy changes, your money isn't trapped in a low-yielding asset.
More in Bonds
At a Glance
Key Takeaways
- It includes an embedded put option for the investor.
- The investor can "put" (sell) the bond back to the issuer early.
- This feature protects the investor against rising interest rates.
- Because it benefits the investor, putable bonds offer lower yields (coupons) than standard bonds.