Bond Types and Structures · Bonds Explained

Read the early repayment option

A callable bond permits the issuer to redeem under specified conditions before maturity. The call schedule identifies dates and prices. Falling borrowing costs can make refinancing attractive to the issuer, just when the investor would prefer to retain a generous coupon.

Imagine paying $1,060 for a bond callable at $1,000 in one year. A $70 coupon followed by that redemption produces $1,070 before costs. The one year gain is only $10, or about 0.94% of the purchase price. The 7% coupon rate does not describe this outcome.

Understand securitisation

Securitisation pools cash flows from assets such as mortgages or other loans and finances them through securities. Payment rules allocate those receipts among different classes, often called tranches. A tranche’s seniority and credit support determine which losses and timing changes it bears.

Owning a senior tranche is not the same as owning every loan directly. You need to understand the pool, the payment waterfall and the conditions that redirect cash.

Watch timing as well as default

Mortgage borrowers may repay early when refinancing becomes attractive. Faster repayment can force investors to reinvest at lower yields. If repayments slow, capital may remain invested longer than expected. This is extension risk.

A forecast based on one assumed prepayment speed is a scenario, not a contractual maturity promise for every dollar. Price sensitivity can change as borrower behaviour changes.

Build a structure checklist

Identify who controls early repayment, when they can act, what amount they pay and how receipts are allocated. Then test a faster and a slower repayment path. A higher stated yield is not useful until you know which path was assumed. Complex structures warrant more detailed analysis than a simple comparison of coupon rates.

Try it yourself

A bond is bought for $1,020, pays a $50 coupon and is called for $1,000 one year later. What is the return before costs?

Show the worked answer

The gain is $30, giving $30 ÷ $1,020, or about 2.94%. The return is below the 5% coupon rate because the purchase premium is lost at redemption.

Further reading

Educational material. Examples are hypothetical and do not recommend a security or a personal allocation. Contract terms and market conventions vary.

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