embedded option

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Embedded option

An option that is part of the structure of a bond that gives either the bondholder or the issuer the right to take some action against the other party, as opposed to a bare option, which trades separately from any underlying security.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Embedded Option

An option or other special provision attached to a bond. For example, an embedded option in a convertible bond is the ability of the bondholder to exchange the bond for shares in the underlying common stock. Likewise, an embedded option may enable the issuer to call a callable bond before maturity. It differs from a bare option, which is the trading of a standalone security separately from any bond.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

embedded option

A provision within a security giving either the issuer or the security holder the right to take a specified action against the other. For example, a call provision is an embedded option in a bond that gives the issuer the right to redeem the bond prior to the scheduled maturity.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.
References in periodicals archive ?
Customers of Future Electronics can now choose from Inventek's wide range of standard and custom embedded options, ranging from low cost system-in-a-package (SiP) products to modular based custom solutions.
For bonds without embedded options, the pricing and risk management are based on statistically and empirically estimated default probabilities and recovery rates.
Furthermore, these contracts contain nonstandard embedded options, for example, the Guarantee Minimum for Death Benefit (GMDB), in which the optional rider is an option whose expiration date is random (the policyholder's death).
Also included in the statements are a number of bond characteristics necessary for specifying each bond's promised cash flow--such as the coupon rate, the month(s) in which the interest payments are made, the schedule of final maturity payments, and the terms of any embedded options. During our period of study, a majority of United States bonds contained call option clauses granting the government the right, but not the obligation, to retire all or part of the issue outstanding for a particular price after a vesting date but before the bond's maturity date (if it had one).
Purely optimizing the end result from the insurance company's perspective will be a challenge because it involves embedded options and policyowner behavior that is difficult to predict, not to mention the need to work with reinsurance partners that have a significant stake in a sound strategy as well.
Be mindful that some asset/liability models may not be capable of producing the requisite yield curve scenarios or may be incapable of valuing embedded options when calculating effective duration.
But ownership rights may be more consequential in the built-in and embedded options because the data and processes are integrated with the internal reporting data and processes, which may be integral to the company's competitive advantage.
To summarize, valuing projects with embedded options requires three major steps:
contract that gives one party certain embedded options. The problem,
The risky bond's yield must also be adjusted to account for other differences between the two types of bonds, such as embedded options, because these would affect the bond's yield and be reflected in the credit spread.
He told FM that one of the main challenges facing gas suppliers was how to value embedded options in wholesale gas purchase contracts.
Buttimer, 2000, "Embedded Options in the Mortgage Contract", Journal of Real Estate Finance and Economics, 21:95-11

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