Features of Debt Securities

5 minutes 5 Questions

Debt securities, also known as fixed income securities, represent loans made by investors to issuers such as corporations, governments, or municipalities. Key features include:1. **Face Value (Par Value)**: The principal amount of the debt to be repaid at maturity, typically $1,000 per bond2. **Cou…

Features of Debt Securities

Understanding the features of debt securities is crucial for the CFA Level 1 Fixed Income section. Debt securities, such as bonds, are financial instruments that represent a loan from an investor to a borrower, typically a corporation or government entity. These securities have several key features that impact their value and behavior in the market.

Important Features of Debt Securities:
1. Maturity: The date on which the principal amount of the bond is repaid to the investor.
2. Coupon Rate: The annual interest rate paid by the issuer to the bondholder, expressed as a percentage of the bond's face value.
3. Face Value (Par Value): The amount that the issuer agrees to repay the bondholder at maturity.
4. Credit Quality: The creditworthiness of the issuer, which affects the bond's risk and yield.
5. Embedded Options: Special features that provide flexibility to the issuer or the investor, such as call provisions or put options.

How Features of Debt Securities Work:
The features of debt securities interact to determine the bond's cash flows, risk, and value. For example, a bond with a higher coupon rate will generally have a higher yield, all else being equal. Bonds with longer maturities tend to have higher yields to compensate investors for the increased risk of holding the bond over a longer period. Credit quality affects the bond's yield, with lower-quality bonds offering higher yields to compensate for the increased risk of default.

Answering Questions on Features of Debt Securities:
When answering questions about the features of debt securities, consider the following:
1. Identify the key features of the bond, such as maturity, coupon rate, and credit quality.
2. Understand how changes in these features affect the bond's value, risk, and yield.
3. Apply the concepts of time value of money, risk and return, and yield curve analysis to the bond's valuation.
4. Be familiar with the different types of bonds, such as zero-coupon bonds, callable bonds, and convertible bonds, and how their features differ from plain vanilla bonds.

Exam Tips: Answering Questions on Features of Debt Securities
1. Read the question carefully and identify the specific feature or features being tested.
2. Understand the relationships between the various features and how they impact the bond's value and risk.
3. Use the information provided in the question to calculate key metrics, such as yield to maturity or duration, when necessary.
4. Be aware of the different yield measures, such as current yield and yield to maturity, and when each is appropriate to use.
5. Practice with a variety of question types, including conceptual questions, calculations, and interpretation of results.

Test mode:

Exam (Timed)

Practice (With explanations)

Start practice test

CFA Level 1 - Features of Debt Securities Example Questions

Test your knowledge of Features of Debt Securities

Question 1

Which of the following is a common feature of a convertible bond?

The bond requires the issuer to set aside funds in a separate account to ensure timely payment of interest and principal to bondholders. The bond can be converted into a predetermined number of shares of the issuing company's common stock at the bondholder's option. The bond includes a provision that allows the issuer to redeem the bond at face value prior to maturity, typically after a specified period.

Correct Answer: The bond can be converted into a predetermined number of shares of the issuing company's common stock at the bondholder's option.

The best answer is that a common feature of a convertible bond is that it can be converted into a predetermined number of shares of the issuing company's common stock at the bondholder's option. This is a key characteristic that distinguishes convertible bonds from regular bonds. The conversion feature provides the bondholder with the potential to participate in the appreciation of the issuing company's stock price. The other two answers, while they may apply to some convertible bonds, are not defining features: - The ability for the issuer to redeem the bond early (a call provision) is a feature found in many types of bonds, not just convertibles. - A sinking fund provision requiring the issuer to set aside funds to ensure timely payments is also not unique to convertible bonds.

Question 2

Which of the following is a feature of a bond with a call provision?

The issuer is required to periodically repurchase and retire a portion of the outstanding bonds at par value to reduce the outstanding debt over time The bondholder has the option to convert the bond into the issuer's common stock at a fixed conversion ratio The issuer has the right to redeem the bond before maturity at a predetermined price

Correct Answer: The issuer has the right to redeem the bond before maturity at a predetermined price

The correct answer is that the issuer has the right to redeem the bond before maturity at a predetermined price. A call provision gives the issuer the option to redeem the bond prior to its maturity date at a specified price, known as the call price. This feature provides flexibility to the issuer, as they can retire the debt early if interest rates decline or if they no longer need the borrowed funds. The other two options are incorrect because they describe features of different types of bonds: - The option for the bondholder to convert the bond into the issuer's common stock at a fixed conversion ratio is a feature of convertible bonds, not bonds with call provisions. - The requirement for the issuer to periodically repurchase and retire a portion of the outstanding bonds at par value is a feature of sinking fund provisions, not call provisions.

Question 3

Robert is considering investing in a bond issued by ABC Corporation. The bond has a face value of $1,000, a maturity of 7 years, and pays a semi-annual coupon of 5%. The bond also includes a provision that allows ABC Corporation to redeem the bond at face value after 4 years. Additionally, the bond has a feature that permits bondholders to convert the bond into ABC Corporation's common stock at a fixed conversion ratio. Given these features, which of the following best describes the bond Robert is considering?

The bond is a callable convertible bond with a 7-year maturity, $1,000 face value, and a 5% semi-annual coupon rate. The bond is a convertible bond with a sinking fund provision, requiring ABC Corporation to set aside funds annually to repay a portion of the principal, and a 7-year maturity, $1,000 face value, and a 5% semi-annual coupon rate. The bond is a putable convertible bond with a 7-year maturity, $1,000 face value, a 5% semi-annual coupon rate, and a provision allowing bondholders to sell the bond back to ABC Corporation at a predetermined price on specific dates.

Correct Answer: The bond is a callable convertible bond with a 7-year maturity, $1,000 face value, and a 5% semi-annual coupon rate.

The bond described in the question is a callable convertible bond. Here's why:

- It has a face value of $1,000, a maturity of 7 years, and pays a semi-annual coupon of 5%.
- The bond includes a call provision that allows ABC Corporation to redeem the bond at face value after 4 years. This makes it a callable bond.
- The bond also has a conversion feature that permits bondholders to convert the bond into ABC Corporation's common stock at a fixed conversion ratio. This makes it a convertible bond.

The other two options are incorrect because:
- The bond is not a putable bond, as there is no mention of a put provision allowing bondholders to sell the bond back to ABC Corporation at a predetermined price on specific dates.
- The bond does not have a sinking fund provision, which would require ABC Corporation to set aside funds annually to repay a portion of the principal.

🎓 Unlock Premium Access

Chartered Financial Analyst Level 1 + ALL Certifications

🎓 Access to ALL Certifications: Study for any certification on our platform with one subscription
1094 Superior-grade Chartered Financial Analyst Level 1 practice questions
Unlimited practice tests across all certifications
Detailed explanations for every question
CFA Level 1: 5 full exams plus all other certification exams
100% Satisfaction Guaranteed: Full refund if unsatisfied
Risk-Free: 7-day free trial with all premium features!

More Features of Debt Securities questions

22 questions (total)

Start 22 question test