Put provision

Definition: A feature of a bond that allows it to be turned in to the corporation which issued it for payment of its loan amount (ie, face value) before its scheduled due (ie, maturity) date.

Example: D & D Corporation issues a 10-year, 4% bond that has a put provision. Several years into the term of the bond, interest rates rise, meaning that similar corporations are now offering new bonds that pay, say, 5%. Investors holding D & D’s bond realize that if they can get all their money back, they could reinvest it in bonds that pay 5%. They can get their money back by ‘putting’ the bond to D & D.

Investeach explains: A second reason why an investor may put a bond is if the corporation is in decline. As this occurs, it becomes less and less likely that it will be able to repay the bond’s face value at maturity. Better to put the bond to the corporation now and collect the face value while the company is still able to pay! Notice that a perception a corporation may fail can make the failure a reality. If enough investors put their bonds back to the corporation it may not have enough money to pay them all!

Bonds with this provision are rare. The reason is that corporations which sell bonds do so to borrow money for the long term. This allows them to make substantial investments in engineers, labs, manufacturing plants, machinery, warehouses, etc. that will one day produce the profits needed to pay back the bonds. When bonds have a put provision, the company can never be sure when and in what amount bondholders will want their money back.

Why would a company offer a put provision on its bond? The ability to put a bond back to a corporation is a valuable feature that can provide significant protection to bond investors. It’s so valuable that they will be willing accept earning a lower than normal interest rate. This means lower interest costs for the corporation.

Riddle me this:

1. In your own words, what does a put provision allow a bondholder to do?
2. Identify two situations in which a bond investor may want to put his or her bond.
3. Why do corporations rarely offer put provisions with the bonds they issue?
4. Still, what is the allure that causes some corporations to offer bonds with a put provision?