How to Account for Puttable Debt

Puttable bonds are not very common and generally carry a lesser credit rating.

Puttable debt refers to a type of bond that allows the investor to redeem the instrument prior to its maturity or at a specified price. At the time the bond is issued, the investor, per the issuer's contract, can choose a predetermined date to redeem the bond's principal amount. Because bonds are generally issued to raise money within a set time frame for repayment that is tied to interest rates, entities that issue puttable bonds must account for early redemptions and how those early redemptions would impact their financial planning.

Instructions

1. Offer a lower yield, relative to the yield that would be offered on a straight bond. The yield is a reward or compensation to the investor for taking the risk and, by nature, puttable bonds are already high-risk, high-yield securities. If there is a recognizable risk of an above-average number of early redemptions, the issuer should adjust the yield by a few basis points to to maximize earnings.

2. Monitor interest rates. Rising interest rates are catalysts for redemption of puttable bonds. With straight bonds, and some puttable bonds, a drop in interest rates will usually cause the issuer to call the bonds and issue new bonds at the lower interest rate. Issuers need to be prepared to take advantage of the lower interest rates if their contracts allow for reissuing of the bonds if the rates fall.

3. Raise separate funds not related to the bond offering, which should be held as a reserve fund to cover redemption shortfalls. Try to put the reserve funds in a interest bearing account.

References

• FASB FAS 133: Derivatives
• Federal Reserve Bank Of Cleveland: Credit Spreads and Subordinated Debt
• FHL Banks Office of Finance: About Callable Bonds

Resources

• IMF Working Paper : Puttable Bonds