What is a Put Bond?
A put bond permits the bond holder to force the issuer to repurchase the security before maturity.
How Does a Put Bond Work?
In bond financing, the issuer sells bonds at a coupon rate (i.e., the interest rate payable on the bonds to the bond buyer) for a specific period of time. The issuer knows that they will have the principal and pay interest on the principal for the term of the bonds. There are two types of redemption options for bonds before maturity:
A call option allows the issuer to redeem the bonds, repaying principal and accrued interest to bond buyer until the time of the call. A call usually favors the issuer, allowing the issuer to refinance or payoff bonds that are issued at a high interest rate.
A put option on the bonds favors the bond buyer in circumstances where the bonds may be yielding a low interest rate during a period when interest rates are rising. A put option gives the bond buyer the right to force the issuer to repurchase the bonds. A put option is usually structured with a series of repurchase dates during the term of the bond.
Why Does a Put Bond Matter?
A put bond favors the bond buyer, giving them flexibility and liquidity in the bond market.
Also, putable bonds are particularly popular in a variety of variable interest rate structures. For example, variable rate demand obligations (VRDO) are 'putable' bonds with a variable interest rate. The liquidity of this type of bond has the effect of allowing the bond to be treated as a short-term investment for the buyer and long-term debt (although with a variable interest rate) for the issuer.