Extendible and Retractable bonds have no fixed maturity date. While the maturity period of extendible bonds can be extended on the demand of the buyer of these bonds, the maturity period of retractable bond can be reduced and the principal amount returned to the buyer if he feels so.
Though the interest rate on the extendible and retractable bonds is low as compared to other bonds, issuers of these bonds are able to sell these bonds because people have the option of either extending the maturity of these bonds or retracting, depending on the interest rate prevailing in the market.
Extendible bonds are generally of shorter tenure but the investor can extend the maturity date of these bonds if the interest rates are falling. If the interest rates are falling, the increase in the price of a short term bond is less than the price of a bond which has a longer maturity date. On the other hand, if the interest rates are increasing, the price of a short term bond will be more than the price of a long term bond.
Retractable bonds are generally of a longer tenure and the investor can reduce the tenure of the retractable bond if the interest rates are rising and get the face value so that he can reinvest it.
Normally, the price of extendible and retractable bonds is higher because the investor gets the option to extend or reduce the maturity period depending on the interest rate prevailing in the market. The issuer of these bonds, however, pays low interest rates. The investor can get interest rate for a long term bond but can exercise his discretion on reducing the maturity period of the bond.
Initially, the issuers used the facility of extending or retracting the maturity as bait to sell more bonds and cost less for issuer as the interest rates paid to the investor is very low.
These days, option pricing techniques are used to decide the pricing of extendible and retractable bonds.
For the issuer:
The main advantage of these bonds for the investors is that they have the option to increase or decrease the maturity period of the bonds depending on their discretion. This will help in protecting their portfolio and reducing the income risk.