To figure out when a call price comes into play, we should first understand what a callable bond is. Think of it as a type of bond where the issuer can "call it in" before it reaches the official maturity date. This usually happens when the issuer wants to protect itself on the off chance that interest rates will decline and they will be stuck paying out a higher rate of interest than necessary. In order to entice customers to buy a callable bond, they usually start out with a higher interest rate than other similar (but non-callable) bonds are paying.
The bonds will also state what the call dates will be and what they will pay as a call price if they do call in the bonds early. The call price will be higher than the original price of the bond as the issuer wants to try and make up for its customers losing out on the higher interest rate payments if the bond had gone to maturity.
Let's say the Ohio State University wants to build more fitness centers for students in order to keep up with what private universities are offering. So, they decide to raise the funds by issuing a $3,000 callable bond with a 5% coupon (interest) rate and a maturity date of January 1, 2020. However, there's a call date of October 31, 2017 with a call price of $3,080. Because this bond issue has a call date, the 5% interest is probably better than what is being offered by similar-risk bonds and maturity dates.
Suppose that in the fall of 2017 interest rates in the market tank, so the University wisely decides to call in the 5% bonds and issue 3% bonds. They will pay their investors a premium of $80 as a call price per bond ($3,080 - $3,000) to help make up for missing out on the higher interest rate for three years. The University wants to refinance their higher interest bonds for lower interest ones in order to incur less debt. Also, when interest rates go down, the price of a bond goes up, so the university can issue new bonds at a lower interest rate and get a higher price.
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Finance: What Is a Put Option?83 Views
finance a la shmoop what is a put option? hot potato hot potato
ow ow! yeah remember that game well nobody wanted the potato, poor thing. the
players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]
of work the same way. a put option is the right or option or choice to sell a
stock or a bond at a given price to someone by a certain end date.
all right example time. you bought netflix stock at the IPO a zillion years
ago at $1 a share. that's you know splits adjusted. all right now it's a hundred
bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in
California that would be a tax of something like almost 40 bucks. well the
stock was a hundred but you keep only something like 60. feels totally unfair.
right so you really don't want to sell your stock but you're nervous about the [graph shown]
next few months that Netflix will crater for a while and go down ten
maybe twenty dollars. longer term though you think it'll hit 300. so this is the
perfect setup to maybe look at buying some put options on Netflix. if the stock
goes down your put options go up. with Netflix volatile but at a hundred bucks
a share ,you look up the price of an $80 strike price put option expiring in
December, and you know that's mid-september now .for five bucks a share
you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]
term life insurance. you pay the five dollars a share in the stock goes down
to 82 by mid December, worst of all worlds. well not only did you lose the $5
a share but your stock has lost $18 in value. but had Netflix really cratered
and gone to say $60 a share well you would have exercised your put and sold
your shares at 80 bucks. well those put options you paid $5 for
would be been worth 15 bucks a share. in buying that put option you've [equation shown]
guaranteed that your loss will be no more than a $75 value for your Netflix
position at least for that time period and ignoring taxes. well remember that
options expire after December whatever like the third Friday of the month it's
usually when options expire, you then have no protection and your shares float
along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]
raunchy. yeah well that's naked put options.
that's what they really are people.
Up Next
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
What is a strike price? Strike prices are used in conjunction with options. Calls and puts give investors the right to buy or sell stocks at predet...