Putable bonds are the opposite of callable bonds and entitle the holder of the bonds to sell them back to the issuer before the maturity date. This is equivalent to the issuer of the bond writing a put option:
Value of putable bond = Value of equivalent straight bond + Value of put option
The put option gives the holder of the putable bond some protection against the effects of higher yields (which may be due to upward shifts in the yield cur ve or may be due to a widening of credit spreads). If market prices fall below the put price the bondholder can exercise their option at the put price.
As the holder of the bond and the holder of the put option are the same party we can get the price of the putable bond by simply adding together the two.The effect is a form of price compression, as yields rise and the bond’s price approaches that of the put price fur ther price falls are truncated. The put price is $7500.
Putable bonds are wor th more than their vanilla equivalent and trade at higher yields to maturity. Put options on long-term bonds are potentially dangerous to issuers because their exercise is out of the control of the issuer.
Bondholders may demand such an option because of concerns about a company’s creditor thiness. The protection offered by put options is, however, limited. If credit spreads at a par ticular issuer widen this is likely to be because of specific problems or weaknesses at the issuer. In the event that bondholders seek to exercise their put option the company may not be able to honor its commitment.