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Embedded option

An option implicit in another instrument. The commonest are: call options embedded in bonds, which allow the issuer to redeem the bond early; the options implicit in bonds with sinking funds; the embedded put provisions in some bonds, that allow investors to put the bond back to the issuer at a predetermined price; the caps in capped FRNs; the equity call options in convertibles and exchangeables; the mortgagee’s prepayment options in mortgage-backed bonds; the options represented by attached debt or equity warrants; the currency options in dual-currency bonds and the debt or interest rate options in pay-in-kind bonds. Embedded currency, commodity, equity and interest rate options have become commonplace in both the private and public debt markets.

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