Puttable bond
A bond that gives the investor the right to seek redemption from the issuer before maturity — useful when interest rates have risen and better-paying bonds are available.
In plain language
A puttable bond is the mirror image of a callable bond. The early-repayment option sits with the investor: on the dates set in the contract, the investor may ask the issuer to repay.
The workbook gives the reason an investor would want it: if interest rates have risen, a puttable bond lets the investor exit a low-coupon bond and reinvest in higher-coupon bonds. It is a built-in escape hatch from being locked into yesterday's rate.
How it works
The workbook's description (section 2.4.2). A puttable bond gives the investor the right to seek redemption before the original maturity date — for example, a 7-year bond with a put option at the end of the 5th year.
Why it matters in the Indian bond market. Section 2.4.4 lists liquidity risk among the risks of investing in debt: limited secondary-market liquidity and the dominance of institutions make it hard for smaller investors to sell, so most end up holding to maturity. Among the consequences the workbook lists: if rates move up, investors cannot easily switch into higher-coupon bonds, and any fall in credit quality during the tenor increases their credit risk. A put option addresses the first of those directly, because the exit comes from the issuer rather than from finding a buyer in a thin market.
| Callable bond | Puttable bond | |
|---|---|---|
| Option holder | Issuer | Investor |
| Likely exercised when | Rates fall | Rates rise |
| Who benefits from the option | Issuer | Investor |
A worked example
Illustrative figures. Rohit buys Rs 5 lakh of a 7-year, 8 per cent corporate bond with a put option at the end of year 5.
Annual coupon = Rs 5,00,000 × 8% = Rs 40,000
By the end of year 5, comparable two-year bonds yield 9.5 per cent. Without the put he could only try to sell in a thin secondary market or wait two more years at 8 per cent. With it, he asks the issuer for redemption and reinvests.
Income at 9.5% = Rs 5,00,000 × 9.5% = Rs 47,500 a year
Extra income per year = Rs 47,500 − Rs 40,000 = Rs 7,500
Over the remaining 2 years = Rs 15,000
Had rates fallen to 6.5 per cent instead, Rohit would simply not exercise the put and keep collecting 8 per cent. Like any option, it is used only when it helps its holder.
Why NISM asks about it
Chapter 2 (Securities: Types, Features and Concepts of Asset Allocation and Investing), section 2.4.2, defines puttable bonds alongside callable and amortizing bonds; section 2.4.4 on liquidity risk explains why an exit right matters. Questions typically ask which party holds the option and in what rate environment it is exercised.
Common exam traps
- The put belongs to the investor. The call belongs to the issuer.
- Puts are exercised when rates rise; calls when rates fall.
- The put can be exercised only on the dates in the bond contract — in the workbook's example, at the end of the 5th year of a 7-year bond.
- A put is not a guarantee against default. It is a right to ask the issuer for repayment; it is only as good as the issuer's ability to pay.
- Do not confuse it with a put option on a share or index, which is an exchange-traded derivative.
Where this is taught
- Series XXI-B · Chapter 4: Investing in Fixed Income Securitiesintroduced here
- Series XXI-A · Chapter 4: Investing in Fixed Income Securitiesintroduced here
- Series X-A · Chapter 9: Investing in Fixed Income Securitiesintroduced here
- Series XII · Chapter 2: Securities: Types, Features and Concepts of Asset Allocation and Investingintroduced here
Related terms
- Reinvestment riskThe risk that the coupons or other intermediate cash flows from an investment have to be put back to work at a lower rate than the original investment earned, pulling the total return below the promised yield.
- Yield to MaturityThe single discount rate at which a bond's future coupons and redemption amount add up to exactly its market price today — the return you actually earn if you hold it to maturity.
- Callable bondA bond that the issuer may redeem before its original maturity date — typically exercised when interest rates fall, leaving the investor to reinvest at lower rates.
- Credit spreadThe extra yield a non-government borrower must pay over a government security of the same tenor — the market price of credit risk, quoted as an add-on over the risk-free rate.
- Coupon rateThe rate of interest a bond pays, applied to its face value and never to its market price — which is why the coupon tells you the cash flow but not the return.