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Embedded Options

Sunday, February 28th, 2010

Embedded Options It is common to grant issuers and bondholders an option to take an action against the other party regarding the owed money, either with the principal or the coupons. Such options have a significant effect on the behaviour of the bond price because of the potential modification of the cash flows that the action may cause. Although not explicitly priced in the market, the options carry implicit economic value and are reflected in the prices of the bonds. These options are known as embedded options.

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