Embedded option

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An embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party.wikipedia
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Bond (finance)

bondsbondbond issue
An embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party.
Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like features to the holder or the issuer:

Puttable bond

putable bond
Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.
Puttable bond (put bond, putable or retractable bond) is a bond with an embedded put option.

Extendible bond

Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.
Extendible bond (or extendable bond ) is a complex bond with the embedded option for a holder to extend its maturity date by a number of years.

Exchangeable bond

exchangeable debt
Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.
Exchangeable bond (or XB) is a type of hybrid security consisting of a straight bond and an embedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under prescribed conditions.

Bond valuation

resultant bond pricebelowBond Valuation — Yield To Maturity
The valuation of these securities combines bond- or equity-valuation, as appropriate, with option pricing.
If the bond includes embedded options, the valuation is more difficult and combines option pricing with discounting.

Preferred stock

preference sharespreferred sharespreference share
Securities other than bonds that may have embedded options include senior equity, convertible preferred stock and exchangeable preferred stock.
Convertible preferred stock—These are preferred issues which holders can exchange for a predetermined number of the company's common-stock shares. This exchange may occur at any time the investor chooses, regardless of the market price of the common stock. It is a one-way deal; one cannot convert the common stock back to preferred stock. A variant of this is the anti-dilutive convertible preferred recently made popular by investment banker Stan Medley who structured several variants of these preferred for some forty plus public companies. In the variants used by Stan Medley the preferred share converts to either a percentage of the company's common shares or a fixed dollar amount of common shares rather than a set number of shares of common. The intention is to ameliorate the bad effects investors suffer from rampant shorting and dilutive efforts on the OTC markets.

Valuation (finance)

valuationinvestment analysisvaluations
The valuation of these securities combines bond- or equity-valuation, as appropriate, with option pricing.
3) Option pricing models, in this context, are used to value specific balance-sheet items, or the asset itself, when these have option-like characteristics. Examples of the first type are warrants, employee stock options, and investments with embedded options such as callable bonds; the second type are usually real options. The most common option pricing models employed here are the Black–Scholes-Merton models and lattice models. This approach is sometimes referred to as contingent claim valuation, in that the value will be contingent on some other asset; see #Contingent claim valuation.

Convertible security

convertible securitiesconvertible debt securitiesConvertible Issues
See Convertible security.
Embedded option

Lattice model (finance)

lattice basedlattice-basedlattice based models
(2) A bespoke "tree" (usually a lattice based short rate model) may be constructed where the option's effect is incorporated at each node in the tree, affecting either the bond price or the option price as specified; see further under bond option.
For callable- and putable bonds a third step would be required: at each node in the time-step incorporate the effect of the embedded option on the bond price and / or the option price there before stepping-backwards one time-step.

Bond option

Bond optionsbelowbond
(2) A bespoke "tree" (usually a lattice based short rate model) may be constructed where the option's effect is incorporated at each node in the tree, affecting either the bond price or the option price as specified; see further under bond option.
The term "bond option" is also used for option-like features of some bonds ("embedded options").

Callable bond

callablebond callscall rates
Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.

Convertible bond

convertible debtconvertible noteconvertible bonds
Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.

Floating rate note

floatersfloating ratefloating rate bonds
Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note.

Mutual exclusivity

mutually exclusivemutually exclusive eventsexclusion
A bond may have several options embedded if they are not mutually exclusive.

Security (finance)

securitiessecuritydebt securities
Securities other than bonds that may have embedded options include senior equity, convertible preferred stock and exchangeable preferred stock.

Stock valuation

equity valuationequity-valuationstock image
The valuation of these securities combines bond- or equity-valuation, as appropriate, with option pricing.

Valuation of options

option pricingoption pricing modeloption price
The valuation of these securities combines bond- or equity-valuation, as appropriate, with option pricing.

Black–Scholes model

Black–ScholesBlack-ScholesBlack–Scholes formula
For bonds here, there are two main approaches: (1) Depending on the type of option, the option price, as calculated using Black Scholes, is either added to or subtracted from the price of the "straight" bond (i.e. as if it had no optionality) and this total is then the value of the bond.

Binomial options pricing model

binomial latticebinomial options modelbinomial
(2) A bespoke "tree" (usually a lattice based short rate model) may be constructed where the option's effect is incorporated at each node in the tree, affecting either the bond price or the option price as specified; see further under bond option.

Short-rate model

short rate modelshort rateMulti-factor short-rate models
(2) A bespoke "tree" (usually a lattice based short rate model) may be constructed where the option's effect is incorporated at each node in the tree, affecting either the bond price or the option price as specified; see further under bond option.

Option-adjusted spread

Option-adjusted spread (OAS) is the yield spread which has to be added to a benchmark yield curve to discount a security's payments to match its market price, using a dynamic pricing model that accounts for embedded options.

Convertible arbitrage

convertible bond arbitrage
In particular, the equity option embedded in the convertible bond may be a source of cheap volatility, which convertible arbitrageurs can then exploit.

Bond convexity

convexity
For a bond with an embedded option, a yield to maturity based calculation of convexity (and of duration) does not consider how changes in the yield curve will alter the cash flows due to option exercise.

Bond duration

durationmodified durationBond-duration
For bonds that have embedded options, such as putable and callable bonds, Modified duration will not correctly approximate the price move for a change in yield to maturity.

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Quark SE
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