NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsMedium
An investor is looking for a debt security that offers a fixed coupon rate for an initial period, after which the coupon rate adjusts periodically based on a benchmark interest rate. Which type of bond best fits this description?
- ACallable Bond
- BFloating Rate Note
- CZero-Coupon Bond
- DReset Bond
Show answer & explanationAnswer & explanation
Correct answer: D. Reset Bond
A reset bond (or 'step-up' bond, though the question's specific description is more aligned with a reset feature) starts with a fixed coupon and then resets to a new, often higher, fixed rate for subsequent periods, or adjusts based on a benchmark for subsequent periods. The key is the 'reset' after an initial fixed period.
Why the other options are wrong
- A. Callable bonds allow the issuer to redeem the bond before maturity, but their coupon rate structure isn't defined by this feature.
- B. Floating Rate Notes (FRNs) have coupon rates that adjust periodically from the outset, typically based on a benchmark, rather than starting with a fixed initial period.
- C. Zero-coupon bonds do not pay periodic interest; they are bought at a discount and mature at face value.
Reset Bond
A debt security that pays a fixed coupon for an initial period, after which the coupon rate 'resets' to a new, often higher, fixed rate or a rate tied to a benchmark for subsequent periods.
- Combines features of fixed-rate and floating-rate bonds.
- Offers investors some protection against rising interest rates after the initial fixed period.
- Can be attractive to issuers wanting to attract initial investors with a fixed rate.
- The reset mechanism is defined in the bond's indenture.
Memory trick: Coupon's Story: Fixed first, then it Resets or Floats.