Chartered Financial Analyst (CFA) Practice Exam Level 2

Which bond feature would likely lead to a lower yield compared to a regular bond?

1. Longer maturity

2. Higher coupon rate

3. Putable bond feature

4. Floating rate feature

The correct answer is: Putable bond feature

A putable bond feature is a significant aspect that can lead to a lower yield compared to a regular bond. This is because a putable bond gives the bondholder the right to sell the bond back to the issuer at predetermined times before maturity, usually at par value. This feature provides the investor with a level of protection against interest rate risks and credit risks, as they can choose to exit the investment if conditions become unfavorable (e.g., if market interest rates rise significantly). Investors are generally willing to accept a lower yield for this extra flexibility and protection, as it mitigates the potential market risk associated with rising rates or deteriorating credit quality. Therefore, despite the bond's lower yield, the embedded option of having the ability to sell the bond back provides value that is factored into its pricing. In contrast, longer maturities typically lead to higher yields due to increased uncertainty over time, as well as a higher coupon rate, which provides greater income upfront. A floating rate feature may also come with yields that adjust with market rates, impacting their yield dynamics as interest rates change, but does not inherently provide the same level of investor protection as a putable feature.