Callable and Puttable Bonds Explained
Most bonds are "bullet" bonds — the issuer borrows for a fixed term and repays at a fixed maturity. But some bonds come with embedded options: the issuer can repay early (callable bonds), or the investor can demand repayment early (puttable bonds). These options meaningfully change the risk and return profile. This guide explains how they work in the Indian context.
Callable bonds — the issuer's option
A callable bond gives the issuer the right (but not the obligation) to redeem the bond before its scheduled maturity, at a specified price and date. The call option belongs to the issuer.
Why issuers want this: If interest rates fall significantly after issuance, the issuer can call the bond and refinance at a lower rate. This is similar to a homeowner refinancing a mortgage when rates fall. The issuer saves on interest costs.
What this means for you as an investor: When rates fall — which would normally cause your bond's price to rise — the issuer exercises the call before you can benefit fully from the price appreciation. Your bond gets taken away at the call price, and you must reinvest at the new, lower market rates. This is reinvestment risk, amplified.
Common structures in India
- Bank perpetual bonds (AT1/Tier 2): These have no fixed maturity, but typically include a call option at 5 or 10 years. Banks are expected (though not obligated) to call them. If they don't call, it can signal financial stress. The Yes Bank AT1 write-down in 2020 highlighted the risks of these instruments for retail investors.
- NBFC bonds with call options: Some NBFC NCDs include call options at 3 or 5 years in a 7 or 10-year bond. If rates fall, the NBFC calls and refinances cheaply. If rates rise, they don't call — and you're stuck with a below-market yield for the remainder.
- European vs American calls: A European call can only be exercised on specific dates; an American call can be exercised any time after the call protection period. Indian bonds typically use European calls at discrete dates.
Yield-to-call vs Yield-to-maturity
When evaluating a callable bond, you need two yield metrics:
- Yield-to-maturity (YTM): Assumes the bond runs to full maturity. Relevant if the issuer chooses not to call.
- Yield-to-call (YTC): Assumes the issuer calls on the first available call date. Relevant if the bond is likely to be called.
Investors should use yield-to-worst (YTW) — the lower of YTM and all YTCs — as the conservative estimate of actual return. If a bond has a YTM of 9% but a YTC of 7.5% (because the call price is close to current market price), your actual return could be closer to 7.5% if the issuer calls.
RetailBonds.in currently shows YTM based on the latest traded price and scheduled maturity. For callable bonds, YTM may overstate likely return if the call is likely to be exercised. Check the bond's offer document for call dates and call prices.
Puttable bonds — the investor's option
A puttable bond gives you, the investor, the right to sell the bond back to the issuer before maturity, at a predetermined price on a specific date. The put option belongs to the investor.
Why investors value this: If interest rates rise significantly after you buy the bond, your bond's market price falls. With a put option, you can force the issuer to buy the bond back at the put price (typically face value or close to it), avoiding the market loss, and reinvest in the new, higher-rate environment.
What issuers give up: By giving investors this put option, the issuer accepts the risk of early redemption. This is particularly relevant if rising rates coincide with the issuer's need for capital. As compensation, puttable bonds typically offer lower coupon rates than comparable non-puttable bonds — the option value is priced in.
Puttable bonds in India
Puttable bonds are less common in the Indian market than callable bonds. Where they do appear:
- Some infrastructure bonds issued in the early 2010s included put-and-call features at 5 years in a 10-year bond, giving both parties flexibility at the midpoint.
- Certain PSU bonds include put options as investor protection features to attract institutional buyers.
Before buying any bond, check the offer document under "Redemption" or "Call and Put Option" sections for the specific dates and prices.
How call and put options affect bond price behaviour
Callable bonds: When yields fall (bond prices would normally rise), the call option caps the upside. The bond's price is limited to approximately the call price because the market knows the issuer will call if the price exceeds that level. This creates "negative convexity" — callable bonds rise less in value when rates fall than comparable non-callable bonds. The lower your callable bond's price appreciation potential, the less you're compensated for duration risk.
Puttable bonds: When yields rise (bond prices would normally fall), the put option provides a price floor near the put price. You won't see the full downside because you can always put the bond back at the put price. This creates "positive convexity" — a more favourable return profile in a rising rate environment — but the cost is a lower initial yield.
What to look for in an offer document
When evaluating a callable or puttable bond, check:
- Call/put dates: When exactly can the option be exercised?
- Call/put price: At what price — face value, at a premium, or a scheduled schedule of prices?
- Notice period: How much advance notice is required? (Typically 30–90 days for calls.)
- Conditions for exercise: Are there any conditions (e.g., regulatory approval for AT1 bond calls)?
- Issuer's stated intention: For AT1 bonds, what has the issuer publicly communicated about their call policy?
AT1 bonds — a special warning
Additional Tier 1 (AT1) bonds issued by banks in India are perpetual (no fixed maturity), callable, and carry loss-absorption features — the issuer can write them down or convert them to equity under regulator-approved stress conditions. These are not equivalent to regular bonds. The RBI's March 2020 decision on Yes Bank AT1 bonds demonstrated that AT1 write-downs can happen suddenly. Retail investors should exercise extreme caution before purchasing AT1 bonds. They are designed for institutional investors with sophisticated risk management capabilities.