put bond

Case Study

A put option on a bond benefits bondholders who are able to force the issuer to redeem its bonds prior to the scheduled maturity. Forced redemptions typically occur following a period of rising interest rates, when bondholders can reinvest their funds at a return higher than the return paid by the bond. Bondholders may also choose an early redemption in the event the issuer runs into serious financial difficulties and bondholders become concerned about whether the issuer will be around on the scheduled maturity date for the bonds. A large issue of put bonds can place the issuer at substantial risk in the event funds are unavailable to pay for a forced redemption. This was the case with Polish conglomerate Elektrim in late 2001 when nearly all of its bondholders decided to exercise a mid-December put on 440 million worth of convertible bonds. Redemption would occur at a premium to par and entail accrued interest requiring the power and telecom company to come up with 488 million. At the time Elektrim said it had 276 million in cash, substantially less than the amount required to pay its bondholders. Likelihood of the redemption caused the firm to search for short-term financing and consider emergency asset sales in order to raise additional funds. Put bonds are uncommon and are generally issued to gain a lower interest cost for the borrower. The risk of put bonds is substantial for the borrower in the event proceeds are invested in long-term assets and the issuer has limited liquidity to redeem the bonds on short notice.