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CFA® Level I · Fixed Income · free lesson
Fixed-Income Cash Flows and Types
Two bonds with the same issuer, maturity and coupon rate can produce very different cash flows. This module shows how principal can be repaid (bullet, amortizing, sinking fund), how coupons can be structured (fixed, floating, step-up, payment-in-kind, inflation-linked and more), and how embedded options such as calls, puts, conversion rights and contingent write-downs shift value between issuers and investors.
What you will learn
1. Describe and compare principal repayment structures, including bullet, fully amortizing, partially amortizing and sinking fund arrangements, and calculate a level amortizing payment.
- Bullet: coupons only, all principal at maturity; highest credit exposure at the end.
- Fully amortizing: level payments of interest plus principal; balance reaches zero at maturity.
- Partially amortizing: some principal repaid during the life, the rest as a balloon at maturity.
- Sinking fund: a set portion retired each year by call (often at par) or by market purchase.
- Faster principal repayment lowers credit risk but raises reinvestment risk.
2. Describe coupon payment structures, including fixed-rate, floating-rate, step-up, credit-linked, payment-in-kind, deferred-coupon, zero-coupon and index-linked bonds.
- FRN coupon = market reference rate + quoted margin, reset periodically; caps protect issuers, floors protect investors.
- Inverse floaters pay more when the reference rate falls.
- Step-up and credit-linked coupons rise on schedule or after a downgrade; PIK pays interest in more bonds; deferred coupons start later.
- Capital-indexed bonds adjust principal for inflation and pay a fixed real coupon rate on the adjusted principal.
- Zero-coupon bonds pay only par at maturity and are issued at a discount.
3. Explain call and put provisions, including call protection and make-whole calls, and identify whether each provision benefits the issuer or the investor.
- Callable bond: issuer's option to redeem early; investor earns a higher yield but faces reinvestment risk and capped price upside.
- Call terms: call price and schedule, call protection period, American, European or Bermudan style.
- Make-whole call price = PV of remaining cash flows at a benchmark yield plus a small spread; rarely used to refinance.
- Putable bond: investor's option to sell back early; lower yield and higher price than an option-free bond.
- The party that holds the option benefits; the other side is paid for it through the yield.
4. Describe convertible bonds, warrants and contingent convertible bonds, and calculate conversion price, conversion value and conversion premium.
- Conversion price = par / conversion ratio; conversion value = conversion ratio x share price.
- Conversion premium = bond price - conversion value (or as a percentage of conversion value).
- Convertibles pay lower coupons than straight bonds because investors receive an equity option.
- Warrants are detachable options on the issuer's shares; exercising them leaves the bond outstanding.
- CoCos convert or are written down automatically at a capital trigger, absorbing losses for the bank.
Module at a glance
- Bullet bonds repay principal at maturity; amortizing bonds repay it over time through level payments.
- Sinking funds lower credit risk but create reinvestment risk when bonds are retired at par.
- FRN coupon = reference rate + quoted margin, limited by any cap or floor.
- Capital-indexed bonds apply a fixed real coupon to inflation-adjusted principal.
- Callable bonds yield more (issuer's option); putable bonds yield less (investor's option).
- Conversion value = conversion ratio x share price; premium = bond price - conversion value.
- CoCos convert or are written down automatically at a capital trigger.
This free module has 4 lessons, 13 practice questions with full explanations.