Risk of a putable bond compare to regular bond?

Question

A bond trader claims that the risk exposure of a 10-year bond embedded with a put option is the same as that of a regular bond with similar features except the put option in the next three years. Do you agree? Please explain.

Answer 1

No dont agree, the volatility of the putable bond will be less then the volatility the option free bond because the put gives the bondholder the right to sell the bond at a specific price

therefore it creates a floor because if yield increases the price decreases

So if it the price decreases below the put level you can still sell the bond at the put level,

so the put creates less price volatility and so the risk will be less

Answer 2

Much of it depends on the conditions of the put option. Some putable bonds can only be exercized if there is a credit event or some other event. Others can be exercised for any reason.

The downside risk of a putable bond is similar to a straight bond with a maturity at the put date. Since the coupon rate is slightly lower -- it is actually is slightly more risky. On the other hand, the upside potential is similar to that of a ten year bond.