• Options available to the Debt security or Bond Holders

    Debt securities and bonds provide some options which benefit the bondholders or the buyers and the loan lenders. These options are

    Put Options

    Put options is same as derivative options which provides the bondholders the right (but not the obligation) to sell the debt securities or bond issue as a whole or just some part of it before the maturity date. This option is enabled only for bonds with put option and this is decided at the time of issuing the bond in the market along with the Put price which is normally fixed near to par value. If the bond or debt securities are sold using the Put option then the bond issuers have to buy back the bonds at put price.

    The Put option can be used only after some period which is called the Put protection period to protect the bond issuers. After the Put protection period, the bondholder can sell the bonds to the bond issuers at any point of time at the pre-decided put price. As it gives additional benefits to the bond holders, the bondholders pay premium price to buy the bonds with put options. That’s why the bonds with put options are sold at much higher price than the normal bonds.

    Value of a Putable Bond = Value of an option free bond + Value of the put option

    Bond holders normally use this put option when the credit rating of the bond issuer decreases and bonds are traded at much below the par value in the market. In that case bondholders exercise the put option and sell the bonds to the issuer at the put price.

    Convertible Option

    Convertible option is used by the bondholders to convert the outstanding debt into common shares of the same issuer. The number of common shares is decided based on the conversion rate.  These types of bonds are called convertible bonds and the conversion rate is either decided at the time of issue or later based on share price and par value of the bond.

    Bondholders use this option when the issuer does not have enough liquidity to pay the interest and principal. At that time, the bondholders convert the bonds into common shares to get ownership in the issuer company. It is much better option rather than losing the whole money. Sometime, the issuer does the restructuring of the existing debt and some bondholders chose to convert the bonds into common shares to get permanent ownership in the company. Having convertible option reduces the value of the bond.

    Floor Coupon payment

    For floating rate bonds, the coupon rate is determined based on some other floating reference rate like LIBOR (London Inter-Bank Offered Rate). The floor coupon option sets the minimum amount for coupon payment even if the reference rate drops lower than that. It protects the bondholders from coupon rate going below a particular level and coupon payment becoming unexpectedly low.

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