SIE Ready💵 Debt Securities · Lesson 7 of 7 · 6 min
Who Holds the Option: Calls, Puts, Conversion
📞 A call feature is the issuer's option. A put feature is yours. Knowing which side holds the option tells you who pays for it.
💡 Key idea
Issuer's option (call) = investor wants more yield. Investor's option (put, conversion) = investor accepts less yield.
🧠 Why it matters
A CALL provision lets the issuer redeem bonds early, often at a small premium. Issuers call when rates FALL, refinancing at a lower cost (REFUNDING); investors then face reinvestment risk, so callable bonds pay higher yields. CALL PROTECTION is the period before the first call date. A PUT feature lets the investor sell the bond back to the issuer, usually at par, which helps when rates rise, so putable bonds pay lower yields. A SINKING FUND sets money aside to retire bonds over time, supporting credit quality. A CONVERTIBLE bond exchanges for stock: conversion ratio = par ÷ conversion price. A $1,000 bond convertible at $40 converts into 25 shares; parity stock price = bond price ÷ 25.
📈 In the real world
🔁 Lakeview Power's 7% bonds have five years of call protection. Year six, rates sit at 4%, and Lakeview calls the issue at 101, refunding with new 4% bonds. Ms. Patel gets $1,010 per bond but can only reinvest at about 4%. Her 7% income stream was the thing being called away.
📌 Takeaways
- Issuers call when rates fall; investors face reinvestment risk
- Puts protect investors when rates rise, so they cost yield
- Conversion ratio = $1,000 ÷ conversion price
📖 Terms in this lesson
Call provision: A clause letting the issuer redeem bonds before maturity at a stated price, most likely after interest rates fall.
Call protection: The period after issue during which a callable bond cannot be called.
Put feature: A clause letting the bondholder sell the bond back to the issuer at a stated price before maturity.
Sinking fund: Money an issuer sets aside over time to retire a bond issue.
✅ Test yourself
An issuer is most likely to call its bonds when:
- Interest rates have fallen
- Its stock price falls
- Interest rates have risen
- Its credit rating drops
Answer: A · Interest rates have fallen
Falling rates let the issuer refund the debt at a lower coupon. When rates rise, the existing bonds are cheap financing and the issuer keeps them.
A $1,000 convertible bond has a conversion price of $50. How many shares does it convert into?
- 50 shares
- 20 shares
- 200 shares
- 5 shares
Answer: B · 20 shares
Conversion ratio = par ÷ conversion price = $1,000 ÷ $50 = 20 shares. 50 is the conversion price itself, not the share count.
Compared with an otherwise identical bond, a putable bond will usually offer:
- A lower yield
- A longer maturity
- A higher yield
- No interest at all
Answer: A · A lower yield
The put is a benefit to the investor (sell back at par if rates rise), so the investor accepts a lower yield. Callable bonds, which benefit the issuer, pay more.
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