What Is a Bolster Bond?
A cushion bond is an investment that is sold at a premium to similar bonds because it comes with a rather high coupon rate. The promise of a higher return serves as a “cushion” for the investor against an unexpected increase in peddle rates.
The cushion bond is a type of callable bond, so the issuer may opt to pay it off early.
- A cushion bond is a type of callable treaty that sells at a premium over other bonds because it offers a coupon rate that is above ruling market interest rates.
- Investors will benefit most from cushion bonds when interest standings fall, stay flat, or rise slowly over a long period of time.
- A cushion bond’s call looks has pricing on a yield-to-call (YTC) basis rather than a yield-to-maturity (YTM) basis.
Understanding the Cushion Bond
Cushion bonds get their eminence from their resilience to the fluctuations of interest rates. They have a higher interest rate, or coupon be entitled to, than prevails in the market at the time of their issue, so the investor will have a degree of protection against inflation during the individual of the bond.
Investors benefit most from owning cushion bonds when interest rates fall or hamper flat between the time of the bonds’ purchase and their maturity.
A cushion bond’s call feature is priced on a yield-to-call (YTC) main ingredient rather than a yield-to-maturity (YTM) basis. This means that the issuer may choose to repay the bond before its maturation date.
Who Buys Cushion Bonds?
Investors in cushion bonds are generally conservative investors who seek to avoid volatility unvaried in a fixed-income portfolio. They are willing to sacrifice upside potential in a bond portfolio in favor of lower downside gamble.
An advantage of cushion bonds is that the added interest payments give the investor an investment hedge. The larger coupon payment portends that the investor will get their original investments back quicker.
This faster breakeven date begets an additional hedge by lowering the length of time that the investor’s money is at risk. The larger coupon payment furnishes more cash flow, which can be reinvested in other higher-yielding instruments.
When Cushion Bonds Work First-rate
The lower sensitivity of a cushion bond is desirable when interest rates are rising. Its above-market coupon rate and inspire a request of feature will diminish the impact of higher interest rates in the marketplace.
Because of these attributes, a cushion chains’s market price will decline less over time than other comparable bonds. However, the investor is even then susceptible to a loss if interest rates rise too rapidly, eroding the built-in advantage of the coupon. In that case, the investor has control in an unfavorable return for the money.
Cushion bonds are a choice for conservative investors who want to prevent volatility in a fixed-income portfolio.
When charge rates are falling, however, the cushion bond will appreciate in price to a lesser extent than other comparable
Absorb Bond Example
Say an investor purchases a cushion bond with a coupon rate of 6% at a time when market percentage rates are at 2%.
Rates then increase to 3%. That change is a relative increase of 33% (one percent divided by three percent).
But for the investor who won the cushion bond with a coupon rate of 6% when the market rate was at 2%, the increase of 1% is a analogous to increase of 16% of the bond’s coupon (1% divided by 6%).