Puttable callable reset bonds

Callable Bonds and Puttable Bonds

Puttable-Callable Reset Bonds — A Quack Deal. In a recent conversation with the Treasurer of a medium sized transnational company which was in some sort of financial stress we learnt that the company has recently issued a puttable-callable reset bond to institutional investors, mostly large pension funds and asset managers.

Puttable and Extendible Bonds: Developing Interest Rate Derivatives for - Salih N. Neftci, Mr. Andre Santos - Google Livres

The issue was underwritten by a big investment bank. The really amazing part was that the underwriting fee that the bank charged the company was ridiculously small. The ostensible reason was that the bank wanted to maintain a very good relationship with the client and at a time of the stress did not want to charge a high fee on the underwriting deal.

Well, the catch was that the same bank was actually the principal in the derivative transaction that was embedded in the deal, i.

The details of the deal are:. January 3, Settlement Date: January 5, Maturity: December 31, Call Date: December 31, Long Put: SA Bank Short Put: ATM at the money Put Underlying 2y UST Put Notional: What the treasurer did not tell us but we sort of read between the lines is that the short put was guaranteed, at least partially, by the assets of the company. A puttable-callable reset bond is a rather simple derivative product which may have disastrous consequences for the issuing companies.

Most investment banks love it because this gives enormous flexibility to them to make money. In the above deal the issuer company sells a 10 year callable bond to the investors, which is underwritten by the bank and at the same time sells a two year put option on the 2 year US Treasury Bond.

The bond can be called back after two years. This, in our opinion is the deal breaker for the issuer. The premium of the put option is very low and obviously the bank had grossly and shall we say, deliberately?

A further interesting feature of the transaction was that the bank did not pay the premium to the issuer up-front, as an option buyer should do, but rather the terms specified that the option will be cash settled two days after the maturity date two years hence.

The callable bond was priced properly and sold to the investor and by charging almost nothing from the issuer as underwriting fees, the bank stood to make nothing from the deal.

Put Bond

However, it did buy a put option from the issuer at the same time, with the same maturity of the embedded call in the bond. And that put option was bought for no upfront cash payment and at a steeply discounted to the fair value price.

US interest rates are likely to rise and bonds markets are likely to experience sharp decline. We are pretty sure the bank is betting on this scenario. This is quite possible if the interest rates in the U. The company will be required to pay this amount to the bank. And if our reading of the situation was correct, then the. But we strongly doubt that the bank will do this, as there is very little incentive to do it.

There is simply no market for this anymore. Of course, the US interest rates may not rise at all and the put option may finish out of the money, which will then be the end of the matter and the company can then go on and either call the bond or live with it for the rest of the term.

But that is the risk that the bank is taking in this deal. We must admit, this is a rare transaction. We were under the impression that such transactions, puttable-callable reset bonds, are no longer in vogue. Any comments and queries can be sent through our web-based form. On A Tangent Investments and Market Analysis QuantLatte Puttable-Callable Reset Bonds — A Quack Deal Team Latte Sept 23, In a recent conversation with the Treasurer of a medium sized transnational company which was in some sort of financial stress we learnt that the company has recently issued a puttable-callable reset bond to institutional investors, mostly large pension funds and asset managers.

The details of the deal are: Expiration Scenario US interest rates are likely to rise and bonds markets are likely to experience sharp decline. And if our reading of the situation was correct, then the bank can force the company to sell assets to pay for the cash settled amount of the put option, which sort of acts a guarantee for the amount if the option is in the money.

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Puttable-Callable Reset Bonds — A Quack Deal Team Latte Sept 23, In a recent conversation with the Treasurer of a medium sized transnational company which was in some sort of financial stress we learnt that the company has recently issued a puttable-callable reset bond to institutional investors, mostly large pension funds and asset managers.

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