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Between 1986 and 1996, 203 putable bonds were issued in the investment-grade market, raising $39 billion. In this study, we find that:
Putable bond issuance increases when the yield curve flattens.
The most common structures in the putable bond market are the 30PUT10 and the 10PUT5. In the 1990s, putable bonds have had longer maturities and longer periods before the put date than the putable bonds issued in the 1980s.
By year-end 1996, seventy-one putable bonds had reached their put date. Only seven of these bonds were put back to the issuers. The remaining sixtyfour bonds were extended.
Bonds that are putable in 2003 will be in high demand to hedge negative convexity in corporate bond portfolios because more than $25 billion of corporate bonds will become callable in 2003. Yields on putable bonds are quoted as a spread above the yield on a reference Treasury bond. The reference Treasury may have a short maturity that equals the put date of the putable bond, or it may have a long maturity that equals the maturity date of the putable bond. The spread-to-put date will tighten when rates fall and widen when rates rise. The spread-to-maturity will widen when rates fall and tighten when rates rise.
Putable bonds represent a cheap source of convexity because they are usually sold at low implied volatilities. To capture this convexity advantage, we recommend that investors buy putable bonds as part of a duration-neutral strategy.
I. PUTABLE BOND VOLUME AND THE SLOPE OF THE YIELD CURVE
In 1996, investment-grade corporations issued fifty-two putable bonds, raising $10.9 billion and accounting for 7.2% of the investment-grade new issue volume. Although the volume of putable bonds increased over that in 1995, it still remained well below the 17.4% share of the new issuance market at the record peak in 1989/Q4. See Exhibits 1 and 2.1
Exhibit 2 also reveals a strong negative correlation between the volume of put bonds and the slope of the Treasury curve. Few corporations issued putable bonds when the yield curve steepened dramatically in 1992 and 1993. In fact, in 1993, only one putable bond came to market, the Associates Corporation 7.95% of 2010, putable in 1998. Conversely, putable bonds accounted for a double-digit share of the corporate...