Putable Bond Valuation Analysis
Given:
Face value: $1000
Coupon rate: 5%
Maturity: 10 years
Putable after 5 years at face value ($1000)
Interest rate after 5 years: 7%
Steps:
1. Calculate the bond's cash flows:
Annual coupon payment: Coupon payment = Face value × Coupon rate = 1000 × 0.05 = $50
2. Determine the present value of the bond's cash flows if held to maturity:
For the first 5 years, coupon payments are $50 each year. At year 5, the bondholder can put
the bond back to the issuer for $1000.
3. Calculate the present value of the bond if the holder exercises the put option after 5 years:
The bondholder will receive $50 each year for the first 5 years and $1000 at the end of year
5 if they exercise the put option.
Present Value Calculations:
1. Present value of coupon payments for the first 5 years:
PV_coupons = sum of (50 / (1 + 0.07)^t) for t from 1 to 5
PV_coupons ≈ $205.01
2. Present value of the face value at the end of year 5:
PV_face_value = 1000 / (1 + 0.07)^5
PV_face_value ≈ $712.99
3. Total present value of the bond if the put option is exercised after 5 years:
PV_bond = PV_coupons + PV_face_value
PV_bond ≈ $918.00
Conclusion:
If the interest rate rises to 7% after 5 years, the bondholder might exercise the put option.
The value of the bond at that time would be approximately $918.00.