Puttable Bond

A puttable bond (also written putable bond, or called a put bond or retractable bond) is a bond whose holder has the right to require the issuer to buy it back before maturity, at a pre-set put price, usually par, on one or more specified dates. Investors exercise the put when interest rates have risen or the issuer's credit has weakened, so they can reinvest the money on better terms.

The put is an option held by the investor. Because it adds value for the holder, a puttable bond pays a lower yield than a comparable straight bond. It is the reverse of a callable bond, where the issuer holds the option and the investor is paid extra. Some bonds carry both features. Under accounting standards the put is an embedded derivative, normally treated as closely related to the debt when the put price is close to par or amortized cost.

Imagine buying a season ticket with a clause that lets you hand it back and get your money refunded at the halfway point. If the team plays badly or something better comes along, you return the ticket. If the season goes well, you keep it. A ticket with that kind of refund clause is worth more, so you accept a slightly higher price or fewer extras for it.

A puttable bond gives the lender a similar way out. If interest rates jump or the borrower starts to look shaky, the investor can hand the bond back and get the agreed amount. In exchange for that safety net, the investor accepts a lower rate of interest than on a bond without it.

• Put dates. Most puts can be exercised only on set dates, often coupon dates after a few years. The holder must usually give notice weeks in advance.
• Put price. Typically par. Some bonds use a schedule or a price slightly above par.
• Change-of-control put. A common clause in US and European corporate bonds, especially high-yield bonds, lets holders demand repayment, often at 101% of par, if the issuer is taken over. It protects investors against a leveraged buyout that loads the company with new debt.
• Rating-triggered puts. Some bonds become puttable if the issuer's credit rating falls below a threshold. These can create sudden funding pressure on a weakened issuer.
• Survivor's option. Certain US retail notes let the estate of a deceased holder put the bond back at par, sometimes called a death put.

Variable-rate demand obligations in the US municipal market are a related form: long-term bonds with short reset periods that holders can tender back regularly, supported by a bank liquidity facility.

A puttable bond is worth the value of an equivalent straight bond plus the value of the investor's put option:

If an otherwise identical straight bond is worth 970 per 1,000 face after rates have risen, and the put option is worth 25, the puttable bond is worth 995. The put acts as a floor: as rates rise, the bond's price falls less than a straight bond's, because it cannot be worth much less than the present value of the put price on the next put date. Investors therefore look at the yield to put as well as the yield to maturity, using the same calculation with the put date and put price in place of maturity and par. The put option gains value with rate volatility and with any rise in the issuer's credit spread.

For investors, the main appeal is protection against interest rate risk and credit deterioration, since a put shortens the bond's effective life when conditions turn bad. Puttable bonds have a shorter, more stable duration than straight bonds of the same final maturity. Pension funds and insurers sometimes use them to match uncertain liabilities.

For issuers, the attraction is a lower coupon. The cost is liquidity risk: the issuer may have to repay large amounts at the worst moment, when markets are stressed and refinancing is expensive. For that reason, rating agencies and analysts often treat debt with near-term puts as if it matured on the put date. Bond documents usually pair puts with other investor protections such as a financial covenant or a cross-default clause.

• Issuer credit risk at the put date. A put is only as good as the issuer's ability to pay. If the issuer is near default, a mass exercise of puts can push it over the edge, and holders may not be paid in full.
• Lower income. If rates stay flat or fall, the put is never used and the investor has accepted a lower coupon for nothing.
• Notice and timing. Missing the notice window means waiting for the next put date, or losing the right altogether.

Puttable features also appear in other fixed income securities, including some floating rate notes and structured deposits, and an equity-linked cousin is the convertible bond with an investor put.

• Financial Industry Regulatory Authority (FINRA)
• Municipal Securities Rulemaking Board