What is the characteristic difference between a callable bond and puttable bond in valuation?

The characteristic difference between a callable bond and a puttable bond in terms of valuation lies in the options they provide to bondholders and their respective impacts on the bond's value.

A puttable bond includes a put option that allows the bondholder to sell the bond back to the issuer at a predetermined price on specific dates before maturity. This feature is valuable to investors, especially in declining interest rate environments, because it provides them with the ability to exit the investment without incurring losses if rates rise or if the issuer’s creditworthiness deteriorates. Consequently, the presence of this put option increases the overall value of a puttable bond relative to similar bonds without such options.

Conversely, callable bonds grant the issuer an option to redeem the bond before maturity, typically when interest rates decline. This feature tends to reduce the value of callable bonds relative to non-callable bonds because investors accept the risk of having their bonds called away when they may wish to continue holding them for higher interest payments. As interest rates decline, the likelihood of the bond being called increases, which can result in lower values for callable bonds.

Thus, while puttable bonds offer an advantage to bondholders through the value derived from the put option, callable bonds do not provide similar benefits and are