NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsHard
An investor is evaluating a fixed-income security that pays a fixed interest rate for a specific period, after which the interest rate resets periodically based on a benchmark rate, such as LIBOR or SOFR. This security is designed to offer stability initially but adjust to changing market conditions. Which type of debt security is this?
- AA callable bond.
- BA zero-coupon bond.
- CA step-up bond.
- DA floating-rate note.
Show answer & explanationAnswer & explanation
Correct answer: C. A step-up bond.
A step-up bond pays a fixed interest rate for an initial period, and then the coupon rate increases (steps up) at predetermined intervals, often to encourage investors to hold the bond if interest rates rise.
Why the other options are wrong
- A. Callable bonds give the issuer the right to redeem the bond before maturity, not a changing interest rate based on a benchmark.
- B. Zero-coupon bonds do not pay periodic interest; they are bought at a discount and mature at face value.
- D. Floating-rate notes have a coupon rate that adjusts periodically based on a benchmark from the start, not an initial fixed period then reset.
Step-Up Bond
A debt security that pays a fixed interest rate for an initial period, after which the coupon rate increases (steps up) at predetermined dates, often to compensate investors for extending maturity or to incentivize holding.
- Fixed rate initially, then increases at intervals.
- Designed to incentivize holding or adjust to market rates.
- Can be callable by the issuer.
Memory trick: A Step-Up bond's coupon 'steps up' over time.