In this workout we look at why a company could potentially consider issuing puttable bonds. The case company here, Company A, has decided to raise £300 million by issuing bonds. The bond and market terms are detailed below. The risk free rate of return is 1.5%. Spread over treasuries for AA rated bonds is 1.35. While for single A rated bonds is 185. Time to maturity is five years and the annual coupon is expected to be one. While the power value is 100. the company decides to target a debt rating of AA, calculate the value of a straight bond and how many bonds would need to be issued in order to raise £300 million required by the company. Well, the price of the straight bond is simple to calculate. We'll use the familiar PV function in Excel and the rate, of course, will be the risk-free rate of return plus the spread over treasuries for a AA rated entity, the number of periods is going to be five years. The coupon is expected to be one and the bonds have a face value or a par value of 100.

So the company expects to raise 91.5 per bond here. So how many bonds do we need to issue? Well, we need to raise £300. £300 million pounds. So we have to sell 3,279,006 bonds.

Now you consider a puttable bond issue rather than a straight bond issue. So the company's looking here, "What if we make these bonds puttable?" Well, let's say we're gonna make them puttable at 98. Well, they then go out and they figure out what the value of this put option is to investors. And in this case, we have decided that the value of that put option is two. I'd like to point out here that this calculation, of course, is pretty complex and requires some serious mathematical modeling, but we are just gonna assume in this case that the value of the put option to the investors is two. We know that a puttable bond is always more valuable than a straight bond, so we can now figure out what the price of a puttable equivalent bond would be. Well, it's simply going to be the price of the straight bond plus the value of the put option, the two.

So the price of the puttable bond is 93.5. So if they decide to issue puttable bonds, how many bonds do they have to issue? Well, £300 million divided by the price per bond, tells us that they would have to issue 3,208,860 bonds. So significantly fewer bonds here if they decide to issue puttable bonds. Puttable bonds, more valuable than straight bonds and the difference there is the value of the put option to the investors.