Callable, putable and convertible bonds

Who controls the feature?

A callable bond gives the issuer a right to redeem the debt before maturity. A putable bond gives the holder a right to require early repayment. A convertible bond gives the holder a right to exchange the bond for common shares under specified terms. The bond agreement determines dates, prices, and restrictions; these features do not eliminate credit or market risk.

Calls and protection

Issuers are more likely to call higher-coupon debt when interest rates fall and refinancing becomes economical. The investor loses the remaining coupon payments and faces reinvestment risk: comparable new bonds may offer lower yields. Call risk can also limit price appreciation as rates fall. A call price may include a premium over par, but that premium does not necessarily offset what an investor paid above par.

Call protection restricts the issuer's ability to redeem during a stated period. It delays the specified call right rather than changing the maturity date. Yield to call assumes redemption at a specified call date and price; yield to maturity assumes repayment at maturity. Neither outcome is promised by the calculation. For covered corporate bond transactions, SEC Rule 10b-10 requires confirmation disclosure that early redemption may affect the represented yield and that additional information is available on request.

Puts and conversion

A holder may find a put valuable when rates rise and comparable bond prices fall, because repayment at the contractual put price can exceed the market sale price. A put is repayment in cash, whereas conversion is an exchange into equity.

Conversion ratio equals par value divided by conversion price. A $1,000 par bond with a $50 conversion price converts into 20 shares: $1,000 divided by $50. If the ratio is already 20 shares and the stock is $55, conversion value is $1,100: 20 times $55. At parity, the bond's market price equals the market value of those shares. The conversion price is a contractual input, not the stock's current quotation.

A convertible can participate in a rising stock price while remaining debt until conversion. In exchange for that equity opportunity, it commonly carries a lower coupon than otherwise comparable nonconvertible debt. Conversion ends the bondholder's interest and principal claims on the surrendered bond and makes the holder an equity owner. A callable convertible can create a decision deadline when called: the holder compares the call proceeds with conversion value before the conversion right expires.