Investment - Embedded Provisions Found in Some Bonds
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Common embedded clauses include call, put, and conversion provisions.

Call 
Call provisions are the issuer’s right to purchase back the bond before to maturity.  

Put
Put provisions are the bondholder’s right to sell back the bond to the issuer before to maturity.  

Conversion
Conversion clauses are the bondholder’s right to convert the bond into shares of the issuer’s stock prior to maturity.  

Callable Bonds
A call provision allows the issuer the right to purchase back the bond issue prior to the maturity date. Bonds that contain a call provision are referred to as callable bonds. A callable bond allows the issuer the right to buy back (or call) the bond from bondholders before to the maturity date at a pre-specified price, referred to as the call price. The call price normally represents the par value of the bond plus an amount referred to as the call premium.  

For most callable bonds, the bond issuer cannot exercise the call provision until a predetermined number of years following issuance. The pre-specified call price at which bonds can be bought back early may be set regardless of the call date, but in most circumstances, the call price changes over time. Under a typical call schedule, the call price tends to drop and move towards the par value over time.  



In general, bond issuers seek to include a call provision so that if interest rates fall after a bond has been issued, they can issue new bonds at a lower interest rate and use the revenues to call the higher interest rate bonds. It is vital to remember that the call provision is a benefit to the issuer and a disadvantage to the bondholder. If called, bondholders are disadvantaged since they would likely have to reinvest the funds in new bonds at lower interest rates.



Consequently, the coupon rate on a callable bond will normally be greater than a comparable bond without an incorporated call provision to compensate the bondholder for the risk that the bond may be retired early. This danger is referred to as call risk. 


Putable Bonds
A put provision offers the bondholder the right to sell the bond back to the issuer prior to the maturity date. Bonds that contain a put provision are termed putable bonds. 

A putable bond allows bondholders the right to sell (or put back) their bonds to the issuer before to the maturity date at a pre-specified price, referred to as the put price. Bondholders could desire to exercise this privilege if market interest rates rise, and they can earn a greater rate by buying another bond that reflects the interest rate increase. Most putable bonds do not start providing bondholders with put protection until a few years after issuance.  

In contrast to the call provision, which is a right of the issuer, a put provision is a right of the bondholder. 

Consequently, the coupon rate on a putable bond will often be lower than the coupon rate on a comparable bond without an incorporated put provision. Bondholders are ready to accept a somewhat lower coupon rate on a bond with a put provision because, should interest rates rise in the economy, they have an opportunity to sell the bonds back to the company and reinvest in new bonds with higher coupon rates.

Convertible Bonds
A conversion clause allows the bondholder the right to swap the bond into a pre-specified number of the issuer’s common shares prior to the bond’s maturity date. Bonds that feature a conversion provision are referred to as convertible bonds.   



Convertible bonds are debt securities prior to conversion, but the fact that they can be converted to common shares makes their value partially contingent on the price of the common shares. 

The number of common shares that the bondholder will get from converting the bond is known as the conversion ratio. The conversion ratio may be stable for the security’s life, or it may change over time.

The conversion value of a convertible bond is the value of the bond if it is converted to common shares. The conversion value is equal to the conversion ratio multiplied by the share price.

If the share price of the firm dramatically increases, the conversion value of the bond will grow and may become more than the value of the convertible bond as a regular bond (i.e., the value of the bond if it were not convertible). If this happens, converting the bond becomes attractive.  



Because the conversion feature is a benefit to bondholders, convertible bonds often offer a coupon rate that is lower than the coupon rate on a similar bond without a conversion feature. At conversion, the bonds are retired (stop to exist) and common shares are issued. If the bonds are not converted to common stock before to maturity, they will be paid off like any other bond and retired at the maturity date. 

Asset-Backed Securities
Securitisation refers to the development and issuing of new debt instruments, termed asset-backed securities, that are backed by a pool of other debt securities. 

The most prevalent sort of asset-backed instrument is backed by a pool of mortgages. In some parts of the world, these asset-backed securities may be referred to as mortgage-backed securities (MBS).

Mortgage-backed securities are based on a pool of underlying residential mortgage loans (home loans) or a pool of underlying commercial mortgage loans.

Mortgage loans are loans to homeowners or owners of other real estate who return the loans through monthly payments.

To produce mortgage-backed securities, a financial intermediary will buy and package a pool of mortgage loans from lenders using a special purpose company. The intermediary will then issue new debt instruments against the bundled pool of home loans.

Typical Asset-Backed Securitisation

Investors who acquire these new mortgage-backed securities earn a part of the pooled monthly loan payments.

Unlike traditional bonds, most asset-backed securities give monthly payments to their owners that comprise both an interest component and a principal component.

Other asset-backed securities are constructed similarly to mortgage-backed securities, only the types of underlying assets varies.

For instance, the underlying assets can include credit card receivables, vehicle loans, and corporate bonds.