{"id":17518,"date":"2021-07-10T22:12:06","date_gmt":"2021-07-10T22:12:06","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=17518"},"modified":"2026-02-27T18:56:54","modified_gmt":"2026-02-27T18:56:54","slug":"describe-fixed-income-securities-with-embedded-options","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/describe-fixed-income-securities-with-embedded-options\/","title":{"rendered":"Fixed Income Securities with Embedded Options"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"What is an embedded option that allows a bondholder to extend the bond\u2019s maturity called?\",\r\n    \"text\": \"An embedded option that allows the bondholder to extend the maturity of a bond is best known as a:\\n\\nA. Extension option.\\n\\nB. Bermudan style call option.\\n\\nC. Estate put.\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is A. An extension option allows the bondholder to extend the maturity of the bond beyond its original maturity date, often at a revised coupon rate. A Bermudan-style call option permits the issuer to call the bond on specified dates, while an estate put allows redemption at par upon the bondholder\u2019s death.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/5zZuTYmjxW8\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p><em><strong>Embedded options<\/strong><\/em> give either the issuer of a bond or the bondholder the right to take advantage of movements in interest rates. Embedded options are attached to a straight (option-free) bond. This makes them bond-dependent, and hence they cannot be stripped and traded separately.<\/p>\r\n<h2>Simple Embedded Option Structures<\/h2>\r\n<h3>Call Options<\/h3>\r\n<p>A <em><strong>callable bond<\/strong><\/em> includes an embedded call option. It can be redeemed before maturity at the discretion of the issuer. Additionally, it has a <em><strong>lockout period<\/strong><\/em>, a period during which the issuer cannot call the bond.<\/p>\r\n<p>Callable bonds can either be:<\/p>\r\n<ul type=\"i\">\r\n\t<li><em><strong>European:<\/strong> <\/em>Exercised only at maturity.<\/li>\r\n\t<li><em><strong>American:<\/strong> <\/em>Can be exercised at any time up to and including maturity.<\/li>\r\n\t<li><em><strong>Bermudan-style:<\/strong> <\/em>An exotic option that is only exercised at predetermined dates.<\/li>\r\n<\/ul>\r\n<h3>Put Options<\/h3>\r\n<p>A <em><strong>putable bond<\/strong><\/em> includes an embedded put option. The put option gives the bondholder the right to put the bond back to the issuer at par before expiration. Similar to the case of a call option, a put option has a lockout period, a period during which the bondholder cannot put back the bond.<\/p>\r\n<p>Putable bonds are mostly European, but they can also be Bermudan. However, there are no American putable bonds.<\/p>\r\n<p>An <em><strong>extension option<\/strong><\/em> has the same structure as a put option. However, it allows the bondholder to extend the bond\u2019s maturity.<\/p>\r\n<h2>Complex Embedded Options<\/h2>\r\n<p>Complex embedded bonds include those with other types of options or a combination of options. They include:<\/p>\r\n<ul type=\"i\">\r\n\t<li><strong><em>Convertible bond:<\/em> <\/strong>This is a bond that has a conversion option that allows the bondholders to convert their holding into the issuer\u2019s common stock.<\/li>\r\n\t<li><strong><em>Callable + putable bond:<\/em> <\/strong>This one comes with both a call option and a put.\u00a0<\/li>\r\n\t<li><em><strong>Estate put<\/strong> <strong>(death put):<\/strong> <\/em>This is a bond that can be put in the event of the holder&#8217;s death. This is usually done by the appointed heirs.<\/li>\r\n\t<li><em><strong>Sinking fund bond:<\/strong>\u00a0<\/em> In this one, the issuer gradually sets funds aside in order to retire the issue, thus reducing credit risk. It is often callable and may have a delivery option<\/li>\r\n<\/ul>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>An embedded option that allows the bondholder to extend the maturity of a bond is <em>best<\/em> known as a (an):<\/p>\r\n<ol type=\"A\">\r\n\t<li>Extension options.<\/li>\r\n\t<li>Bermudan style call option.<\/li>\r\n\t<li>Estate put.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is A.<\/strong><\/p>\r\n<p>An embedded option resembles a put option. At maturity, the holder of an extendible bond has the right to keep the bond for several years after maturity, potentially with a different coupon.<\/p>\r\n<p><strong>B is incorrect. <\/strong>A Bermudan-style call option can be exercised only on a predetermined schedule of dates after the end of the lockout period specified in the bond\u2019s indenture.<\/p>\r\n<p><strong>C is incorrect. <\/strong>An estate put (\u201cdeath put\u201d) option can be redeemed at par by the deceased bondholder\u2019s heir.<\/p>\r\n<\/blockquote>\r\n<p>Reading 30: Valuation and Analysis of Bonds with Embedded Options<\/p>\r\n<p><em>LOS 30 (a) Describe fixed-income securities with embedded options.<\/em><\/p>\r\n\n            <div \n                class=\"elfsight-widget-pricing-table elfsight-widget\" \n                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Embedded options are attached to a straight (option-free) bond. This makes them bond-dependent, and hence they cannot be&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,472],"tags":[],"class_list":["post-17518","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-fixed-income","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Bonds with Embedded Options | CFA Level 2<\/title>\n<meta name=\"description\" content=\"Learn how embedded options affect bond valuation, including callable, putable, and death put bonds in CFA Level 2 fixed income.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" 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