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Home » Investment Planning » Bonds and Security » Putable Bonds

Putable Bonds

Bonds that are putable include an option for the investor to mature the debt at an earlier date than the final stated maturity date. Putable bonds are advantageous to the buyer of the security and therefore offer a lower yield level than comparable non-putable securities. The investor will want to take advantage of the put option and mature the bonds early if interest rates rise between the time the bonds are issued and the put date. Why? Because the investor can then purchase another bond with the same remaining maturity date at a higher interest rate and earn a higher rate of return over the life of the original expected holding period. If interest rates fall and the bond is not put back to the issuer, the investor in the bond will have the disadvantage of earning a lower yield level until the maturity date than if the same bond was bought as a non-putable security. The dollar price of the bond will determine whether the bond is trading to the put date or to maturity; bonds trading at a discount to par will trade to the put date and bonds trading at a premium will trade to the maturity date.

One of the main difficulties for fixed income portfolio managers in managing bonds with put dates is the problem of maintaining a set duration, or level interest rate exposure, for the portfolio, because of duration drift. As interest rates rise, in particular, putable bonds will begin to start trading to the shorter put date and will therefore experience a shortening of their duration. If interest rates are rising and bond prices falling, bond managers will want to have the shortest duration possible in their portfolio to keep price declines to a minimum, which is exactly what occurs. This is another way of showing that putable bonds place the option benefit in the hands of the investor and not the issuer.



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