Bond Options and Variants
When a bond is issued, especially if it is a long dated one, the issuer may want to have some flexibility about when it is repaid. This could arise, inter alia, because:
- the issuer's circumstances have changed in such a way that the loan is no longer needed or
- 1as interest rates have dropped, the issuer can refinance the loan more cheaply or
- the covenants on the loan prevent the issuer raising more capital in the most appropriate way.
Such an option that gives the issuer a right to redeem all or part of a bond early is called a ‘call’ option.
Another variant of this is when the issuer wants to redeem the bond in stages, instead of in one go, via a sinking fund. This may occur when the issue is relatively large compared to the size of the issuer.
In the case of collateralized mortgage bonds securitized with a pool of mortgages, the bond will be repaid according to when the underlying mortgages themselves are paid off. The bond is thus redeemed in a number of tranches of unknown size.
In a similar way, in order to make a bond more attractive to an investor, the issuer may grant the investor a variety of different options. These can vary from:
- a ‘put’ option, which gives the investor the right to request early repayment of the capital on a specific date or dates;
- having warrants to purchase other assets attached;
- automatically increasing the coupon rate, if the rating of the bond issue is reduced;
- having the right to convert the bonds at predefined rates ...