Fixed-Income Types: Structure of a Bond’s Cash Flows

This is because the investor will get some of the principal earlier with the amortizing bond. So once some cash is in hand, there is less risk of default on the total principal, and there's also less interest rate risk, or the risk that the bond's value will change drastically with rising or falling rates.

Bonds are quite popular. The typical, conventional types have a simple payment structure. Coupon payments of a fixed amount every so often, and then a single principal payment at maturity.  This bond cash flow diagram shows a bond with a face value of $4,000, a tenor of five years, and a 3.5% coupon.

What type of bond do you think would probably pay the investor more if a central bank chose to raise reference rates?

No, this is usually a fixed and preset schedule of payments that just increase after a given number of periods.

Incorrect. It's true this higher reference rate would reduce the value of most existing bonds, but there is an exception here.

Yes! A higher market reference rate (MRR) would increase the coupon of a floating-rate note, so it would therefore pay more to investors due to this higher MRR.

To summarize this discussion: [[summary]]

Then there are the coupons. This makes a pretty big list of bond types, since there are so many different ways to set up coupon payments. A conventional bond has fixed coupon payments every period. But perhaps the firm is worried about cash flow in the early years of the bond. Then they might issue a __step-up bond__ to start with a low coupon and pay a higher coupon later. Or the payments might not be fixed at all. They might be some spread over a reference rate, as in a __floating-rate note__. The payments might depend on the firm's credit rating, making it a __credit-linked note__. Or the payments might be linked to some index, making it an __index-linked bond__.

But there are variants. Many variants. For one thing, bonds can have different principal repayment structures. Perhaps the principal is paid in a single payment at the end, which is called a __bullet bond__, or perhaps the principal is __partially amortized__ or __fully amortized__ over the bond's tenor. This means the principal is paid along with the interest payments, so the investor receives larger chunks of cash as they go, with less, or possibly the exact same payment, at maturity.

What do you think would provide the investor with less risk?

No, actually this is the higher risk bond of the two. The fully amortized bond provides the investor with less risk.

That's right!

Some bonds don't start coupon payments until a few years have passed, some are linked to equity markets and some have embedded options in them to be called, put, or converted into something else. Each of these flavors present challenges both to investors and analysts. Valuation of a basic, conventional bond just requires a return assumption, which alone is a challenge. But valuation of these exotic bonds requires more thought and time. But the answer to almost any question about the existence of a type of fixed income security is that, yes, there's a bond for that.

Step-up bond

Floating-rate note

Neither of these; this would decrease the value of any bond

A bullet bond

A fully amortized bond

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