LOS e Describe Securities: Defining Elements LOS e Describe Securities: Defining Elements

Fixed Income Cash Flows Fixed Income Cash Flows

Bullet structure: Interest only on coupon dates, all principal
repaid at maturity (plain-vanilla bond)
Partially amortizing: Periodic payments include interest and
principal, with balloon payment
Fully amortizing: Equal payments each period include
interest and principal (e.g., mortgage loan)
Sinking fund: Some bonds are retired or redeemed early on
scheduled dates
© Kaplan, Inc. 16
Floating-rate notes (FRN): Coupon rate based on a
reference rate (e.g., 6-month Libor) plus or minus a fixed
margin
 Cap, maximum rate (benefits issuer)
 Floor, minimum rate (benefits bondholder)
Inverse floater: Coupon rate = X% – reference rate
© Kaplan, Inc. 17

LOS e Describe Securities: Defining Elements LOS e Describe Securities: Defining Elements

Fixed Income Cash Flows Fixed Income Cash Flows

Step-up coupon: Coupon rate (fixed or floating) increases on Index-linked Bonds
a schedule; likely called prior to step-up if credit unchanged
Coupon rate or principal changes based on value of a
Credit-linked coupon: Coupon rate increases if credit rating published index.
decreases, decreases if credit rating increases
Inflation-indexed bonds (CPI)
Payment-in-kind: Issuer may make coupon payments by
increasing principal amount Equity-linked notes (equity index)

Deferred (split) coupon: Coupon payments do not begin until Commodity-indexed bonds (commodity price, e.g., gold, oil)
a period after issuance
© Kaplan, Inc. 18 © Kaplan, Inc. 19

1
LOS e Describe Securities: Defining Elements LOS f Describe/Identify Securities: Defining Elements

Fixed Income Cash Flows Embedded Options

Inflation-linked bonds (linkers) have payments that are
adjusted based on CPI
Interest-indexed: Coupon rate adjusted
Capital-indexed: Principal (par) value adjusted, coupon rate
remains fixed (e.g., TIPS, zeros)
Indexed-annuity bonds: Fully amortizing, payments adjusted
Principal-protected: Pay original face value if index
decreases over life of bond
© Kaplan, Inc. 20
Contingency provisions (embedded options) are actions the
issuer or bondholder may take
Callable bonds: Issuer may redeem bonds before maturity
on scheduled call date(s) at specified call price(s)
 Bonds may have a period of call protection
 Make-whole provision: Call price includes present value
of future coupons
© Kaplan, Inc. 21

LOS f Describe/Identify Securities: Defining Elements

Embedded Options
Putable bonds: Bondholder may sell bond back to issuer,
typically for par value
Convertible bonds: Bondholder may exchange bond for
issuer’s common stock
Warrants: Right to buy issuer’s common shares at a given
price (attached to straight bond)
Contingent convertibles: Convert to common stock
automatically if specified event occurs
© Kaplan, Inc. 22