Bonds with Embedded Options

Overview

Some bonds are issued with embedded options. That is, they come with additional rights, either for the issuer or the purchaser. This rights have a cost, and are added into or subtracted from the bond price when initially sold and whenever it is traded.

Pricing of the embedded options typically uses the modeling used in derivatives pricing.

Bonds with Options Types

• Callable Bonds: are bonds where the issuer has the right to "call" the bond and pay the principal early, thereby stopping interest payments.
• Convertible Bonds: are bonds that are convertible to some other asset, typically the equity of the issuer.