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CFA Level I · CFA Level I Exam · Fixed-Income Cash Flows and Types

A bond has a put option that lets the bondholder sell the bond back to the issuer at par on any coupon date. The put is most likely to be exercised when:

The put is most likely exercised when market interest rates have risen well above the coupon rate. The bond's market value then falls below par, so the holder gains by selling it back at par and reinvesting the proceeds at the higher prevailing yields.

  1. Amarket interest rates have fallen well below the coupon rate
  2. Bmarket interest rates have risen well above the coupon rateCorrect
  3. Cthe issuer's credit quality has improved sharply and spreads have narrowed

Explanation

If rates rise above the coupon, the bond's market price falls below par. The holder can then put it at par and reinvest at higher yields. When rates fall or credit improves, the bond trades at or above par, so the put is not worth exercising.

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