Embedded Option

AAA

DEFINITION of 'Embedded Option'

A provision in a security that is an inseparable part of the other instrument. An embedded option is a special condition attached to a security, and in particular, a bond that gives the holder or the issuer the right to perform a specified action at some point in the future. An embedded option is part of another security, and as such does not trade by itself. Nevertheless, it can affect the value of the security of which it is a component. A security is not limited to one embedded option, as there may be several embedded options in one security.

INVESTOPEDIA EXPLAINS 'Embedded Option'

A call provision, for example, is an embedded option in a bond that would give the issuer the right (but not the obligation) to redeem the bond before its scheduled maturity. In a convertible bond, however, an embedded option may give the holder the right to exchange the bond for shares in the underlying common stock. The presence of embedded options affects the value of the security, and investors should be aware of any embedded options and the potential outcome or impact. For example, a bond that has an embedded option, giving the issuer the right to call the issue, could be less valuable to an investor than a noncallable bond. This is because the investor could lose out on interest payments to which he would otherwise be entitled if the bond were held to maturity (assuming the issuer does call the issue).

RELATED TERMS
  1. Locally-Capped Contract

    A type of embedded option found in structured investment products, ...
  2. Globally-Capped Contract

    A type of option that guarantees a minimum return but puts a ...
  3. Rolling Option

    A contract that offers a buyer the right to purchase something ...
  4. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  5. Option

    A financial derivative that represents a contract sold by one ...
  6. Make Whole Call (Provision)

    A type of call provision on a bond allowing the borrower to pay ...
RELATED FAQS
  1. Where can I find year-to-date (YTD) returns for benchmarks?

    Benchmarks are securities or groups of securities against which investment performance is analyzed. Examples of popular equity ... Read Full Answer >>
  2. What is the effective interest method of amortization?

    The effective interest method is an accounting practice used for discounting a bond. This method is used for bonds sold at ... Read Full Answer >>
  3. Under what circumstances would someone enter into a repurchase agreement?

    In finance, a repurchase agreement represents a contract between two parties, where one party sells a security to the other ... Read Full Answer >>
  4. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  5. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
  6. What type of asset allocation should I use if I am already retired?

    Among investors, asset allocation is a topic of discussion that receives a great deal of weight during the asset accumulation ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  2. Options & Futures

    Principal-Protected Notes: Hedge Funds For Everyday Investors

    PPNs guarantee to return at least 100% of the original investment and have the potential to return much more.
  3. Professionals

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  4. Stock Analysis

    Playing Rising Rates with Ultra-Short Term Bonds

    With rising rates likely, investors may want to consider adding a dose of ultra-short bonds to their portfolios. Here are some ETFs to consider.
  5. Professionals

    Why Investors Are Bailing on Bond ETFs

    Investors are fleeing bond ETFs. Should you follow the herd? Hint: It depends on the type of bond.
  6. Professionals

    Is a Bond Market Selloff Coming?

    A big investment management company is concerned about bond market conditions and allocating more capital to cash. Should you follow?
  7. Credit & Loans

    What is a Syndicated Loan?

    A syndicated loan is one that involves a group of lenders (called the syndicate) who pool their lending resources to make a loan.
  8. Investing Basics

    What is a Greenshoe Option?

    A greenshoe option is a provision in an underwriting agreement that allows the underwriter to buy up to 15% of the shares in an IPO at the offer price.
  9. Investing Basics

    What Does a Clearing House Do?

    A clearing house is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets.
  10. Investing Basics

    What is an Asset-Backed Security?

    An asset-backed security (ABS) is a debt security collateralized by a pool of assets.

You May Also Like

Hot Definitions
  1. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  2. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  3. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  4. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  5. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  6. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!