Some bonds have embedded options which either allow the issuer to buyback the bonds before the maturity or the holder of the bonds to sell the bonds to the issuer before the maturity. Such options are explicitly stated in the offer document at the time of the issue of the bonds. Call or put options on bonds may alter our cash flows significantly in future.
Callable bonds: Bonds which give the issuer right to buy back the bonds before its maturity are called callable bonds. Callable bonds usually come with an initial lock‐in period. Since investing in such bonds exposes the investor to the additional risk of buyback they usually offer a higher rate of interest as compared to bonds without such options.
Before buying callable bonds, ensure that you understand the prepayment risk associated with the bond.
Puttable bonds: Bonds which give the investor the right to sell the bonds back to the issuer before the maturity of the bond are called puttable bonds. Since such bonds give the investor a right to sell before maturity, they usually offer a lower rate of interest as compared to bonds without such options. A puttable bond may cost more than a normal bond due to the option attached to it.
Hence, consider the benefit you derive from the option with the cost associated with it and buy it only if you feel it’s worth the investment.