Question

Which of the following is true about a municipal bond with a put option? (A) An investor will exercise the option to put the bond if yields rise significantly. (B) An investor must have the issuer's permission to put the bond. (C) The market price of bonds is never affected by a put option feature. (D) Yields are usually higher for a new issue bond with a put option than for a new issue bond without a put option.

Answer 1

Answer:

(A) An investor will exercise the option to put the bond if yields rise significantly

Explanation:

A put option on the bond is a mechanism to allow the buyer of the bond the ability to compel the lender to repay the principal on the bond. The put option offers the buyer of the bond the ability to collect the principal of the bond anytime they choose until maturity for any purpose.

Recall that once the price drops (that is, the yield increases), put options are exercised. If the yield significantly increased, the put choice on a municipal bond is executed.