Bond features, covenants and munis
By SuperdayReps · Michigan Ross Undergrad | Wharton MBA · ex-Citi | ex-Greenhill · Former Head Mentor at a Leading IB Prep Service
14 min read · updated November 3, 2026
Two bonds from the same company, maturing the same year, can trade 100 bp apart. The difference is in the fine print: one can be called away, one has a covenant package and the other does not, one can be swapped into stock. A credit trader prices that fine print every day, and a salesperson has to explain it to a client in a sentence.
Interviewers use these features to test whether you understand options and incentives rather than definitions. The question behind almost every one is "who holds the option, and what is it worth to them?" Municipal bonds add one more twist, taxes, which makes the yield on the screen the wrong number to compare.
Ask who holds the option, because whoever holds it pays for it. An issuer that can call a bond pays a higher yield; an investor who can put a bond back, or convert it into stock, accepts a lower one. And compare bonds on what the holder actually keeps: yield to worst for a callable, tax-equivalent yield for a muni.
The map
| Feature | Who holds the option | Effect on yield | How it is quoted or valued |
|---|---|---|---|
| Callable | Issuer | Higher | Yield to worst, OAS |
| Puttable | Investor | Lower | Yield, with a price floor near the put price |
| Perpetual | Nobody, unless it is also callable (most are) | Higher | Coupon divided by yield, usually priced to the call |
| Eurobond | Not an option, a place of issue | Depends on the issuer | Same as any bond |
| Convertible | Investor | Much lower | Bond floor plus an equity call option |
| Tax-exempt muni | Not an option, a tax break | Lower on the screen | Tax-equivalent yield |
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Frequently asked
- Who benefits from a callable bond?
- The issuer. It owns the right to buy the bond back early, and it uses that right when rates fall or its credit improves, which is exactly when the investor would rather keep the bond. Investors charge for selling that option by demanding a higher yield than on a plain bond.
- How do you calculate the tax-equivalent yield on a muni?
- Divide the muni's yield by one minus the investor's tax rate. A 3.5% tax-exempt muni is worth 3.5 / 0.63 = 5.56% to someone in a 37% bracket, so it beats a 5.2% taxable corporate bond. To someone in a 24% bracket it is worth only 4.61%, so the corporate wins.
- What is the difference between maintenance and incurrence covenants?
- A maintenance covenant is tested every quarter whatever the company does, and failing it is a default. An incurrence covenant is only tested when the company tries to do something, like borrow more or pay a dividend, and failing it just blocks that action. Bank loans traditionally carry maintenance tests; high-yield bonds carry incurrence covenants only.
- What is convertible arbitrage?
- A hedge fund strategy that buys a convertible bond and shorts the issuer's stock against the option inside it, sized by the option's delta. The fund is not betting on the stock's direction. It earns the coupon, interest on the short sale proceeds and profits from rebalancing the hedge as the stock moves, and it carries credit, borrowing and liquidity risk.
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