CFA Level IFixed IncomeEasy
An analyst is comparing two bond structures. Bond X repays 100% of its principal in a single lump sum at maturity. Bond Y repays its principal gradually over its life through scheduled payments that include both interest and principal, similar to a mortgage loan. Bond Y is best described as a(n):
- APutable bond
- BBullet bond
- CAmortizing bond
- DPerpetual bond
Show answer & explanationAnswer & explanation
Correct answer: C. Amortizing bond
An amortizing bond repays principal gradually over the bond's life through a schedule of payments that combine interest and principal, rather than returning the full principal at maturity. A bullet bond (Bond X) repays 100% of principal at maturity, a perpetual bond has no maturity, and a putable bond gives the holder the right to sell the bond back to the issuer.
Why the other options are wrong
- A. A putable bond gives the bondholder an option to sell the bond back to the issuer; it does not describe the principal repayment structure.
- B. A bullet bond repays the entire principal as one lump sum at maturity, which describes Bond X, not Bond Y.
- D. A perpetual bond never matures and pays coupons indefinitely, which is unrelated to the scheduled principal repayment described.
Amortizing Bond
A bond whose principal is repaid gradually over its life through scheduled payments, rather than as a single lump sum at maturity.
- Each payment includes both interest and principal, like a mortgage.
- Fully amortizing bonds have zero principal remaining at maturity.
- Contrasts with bullet bonds, which repay all principal at maturity.
Memory trick: Amortizing = 'a mortgage-like' bond — principal melts away over time.