State Bank Of India 9.95% (SBIN-N5) Bond is currently trading at Rs.10,969 and yields to maturity are showing as 8.61% as of 28th August 2020. During the current low-interest regime, people are obviously looking for this investment as attractive. However, they are all forgetting the call option of 2021. What happens if the bank call the bonds?
Long back, I have written a post on this. You can refer the same for detailed understanding and feature of this particular bond “State Bank Of India 9.95% (SBIN-N5) Bond – Should you invest 9% Yield Bond?“.
State Bank Of India 9.95% (SBIN-N5) Bond Call Option – What if the Bank exercised in 2021?
How many of us actually understand the call or put options of the Bond market? Sadly few. Because we are blindly chasing the yield than the risk involved in the bond market.
A callable bond is a bond in which the issuer has the right to call the bond away from the investor for a price determined at the time that the bond is issued.
Let us take an example of this State Bank Of India 9.95% (SBIN-N5) Bond. SBI is paying you the 9.95% coupon on this bond. However, if you look at the current interest trend and in fact the FD rates of SBI, you notice that this coupon rate is costing heavily to SBI. Hence, the bank may call the bond from the investor from future obligations of high coupon rate payment. Then issue the fresh bond in the market at a lower coupon rate (matching the current interest rate trend).
A puttable bond, allows the investor to sell the bond back to the issuer, prior to maturity, at a price that is specified at the time that the bond is issued.
Let us take an example of this State Bank Of India 9.95% (SBIN-N5) Bond. SBI is paying you the 9.95% coupon on this bond. Assume that the current interest rate trend is high and there are many bonds available in the market which may be offering you the higher coupon say like 11%, then will you hold this low yield bond? Obviously you are losing the earning due to holding of this low yield or low coupon bond.
Hence, when the bond feature provide the put option, he will exercise and sell it back to the issuer.
Simple to say, the call option gives the right to the issuer to call back the bond and save his future high coupon obligation (when the interest rate is falling). At the same time, the put option gives the right to holder of the bond to sell the low yielding bond to the issuer back (when the interest rate is going up).
The current situation is favorable for State Bank Of India 9.95% (SBIN-N5) Bondholders but not the issuer (SBI Bank). Hence, obviously SBI bank may exercise the call option which is immediately after the completion of 10 years i.e 16th March 2021.
If such an event happens, then what will be the yield for those who are trying to buy the State Bank Of India 9.95% (SBIN-N5) Bond at today’s price of Rs.10,969?
Let us input the values as below in Bond Calculators and you will find the results as below. I am not sure whether during the call option the SBI Bank will repay just the face value or face value with a year coupon. Hence, let us consider both options to arrive at a possible yield.
# Scenerio 1 – You just receiving the face value at call option.
Callable Date-17th March 2021 (Immediately after the 10 years completion) and this means the year left to call is around 0.57 years.
Then the yield to maturity is around -14%. Therefore those who are buying today the bond at Rs.10,969 will end up in negative returns of around -14%.
# Scenario 2 – You are just receiving the face value at call option and one-year coupon of Rs.995=Rs.10,000 (face value)+Rs.995 (one yar coupon)=Rs.10,995. In this scenario also, the yield to maturity will be around 1.3%.
But if you look at the volume traded, traded volume as of 28th August 2020 is 1,579. I can understand the knowledge of those who are selling currently. But there are few buyers also. This surprises me. Who is buying this bond especially when the call option is just around 6 months away?
Look at the price movement of the bond since it’s inception, you notice that there is no such a huge fall in price even though the probability of call option is so near.
Conclusion:-Buying SBI Bank Bond is not the SAME as investing in SBI Bank FD. Both are entirely different products. However, many fail to understand this. In fact many buy such bonds only because it is by SBI, coupon rate is high and maturity is in 2026. Beware before jumping into any bond investment.
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