Cushion Bond

AAA

DEFINITION of 'Cushion Bond'

A type of callable bond that sells at a premium because it carries a coupon rate that is above market interest rates. A cushion bond's call feature means that it will be priced on a yield-to-call basis (meaning it can be redeemed prior to maturity), rather than on a yield-to-maturity basis; this relatively shortened maturity decreases its sensitivity to changes in interest rates. A cushion bond is so called because its resilience to interest rate fluctuations provides a cushion or a degree of protection against rate changes, especially when they are rising.

INVESTOPEDIA EXPLAINS 'Cushion Bond'

Cushion bonds may be especially suitable for conservative investors who do not wish to see too much volatility in the value of their fixed income portfolios. Such investors may be willing to sacrifice upside potential in their bond portfolio for the benefit of lower downside risk.

For other investors, the lower sensitivity of a cushion bond may be a desirable attribute when interest rates are rising, since its above-market coupon rate and call feature will diminish the impact of higher interest rates. As a result, the cushion bond's market price will decline less than other comparable bonds without these features.

When interest rates are falling, however, the cushion bond will appreciate in price to a lesser extent than other comparable bonds that are non-callable and have lower coupon rates. This may make cushion bonds less desirable to the average investor during periods of falling interest rates.

RELATED TERMS
  1. Coupon

    The interest rate stated on a bond when it's issued. The coupon ...
  2. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity ...
  3. Forced Conversion

    The occurrence of an issuer of a convertible security exercising ...
  4. Yield To Call

    The yield of a bond or note if you were to buy and hold the security ...
  5. Premium

    1. The total cost of an option. 2. The difference between the ...
  6. Callable Bond

    A bond that can be redeemed by the issuer prior to its maturity. ...
RELATED FAQS
  1. How can I create a yield curve in Excel?

    You can create a yield curve in Microsoft Excel if you are given the time to maturities of bonds and their respective yields ... Read Full Answer >>
  2. What are the different formations of yield curves?

    There are three main different formations of yield curves: normal, inverted and flat yield curves. The yield curve describes ... Read Full Answer >>
  3. How does a bond's coupon rate affect its price?

    A bond's coupon rate has a large effect on its market price because it dictates the amount of income the bond generates per ... Read Full Answer >>
  4. What is the difference between an option-adjusted spread and a Z-spread in reference ...

    Unlike the Z-spread calculation, the option-adjusted spread takes into account how the embedded option in a bond can change ... Read Full Answer >>
  5. In what ways can a sinking fund affect bond returns?

    The effective yield of a bond sinking fund to an investor should not be considered similar to a bond nonsinking fund. Both ... Read Full Answer >>
  6. What is a barbell fixed-income strategy?

    A barbell fixed-income strategy is an investment strategy in which a portfolio is comprised of long- and short-term bonds. ... Read Full Answer >>
Related Articles
  1. Bonds & Fixed Income

    5 Reasons To Trade Bonds

    Investors can find great financial opportunities in the bonds markets.
  2. Retirement

    Bond Basics Tutorial

    Investing in bonds - What are they, and do they belong in your portfolio?
  3. Bonds & Fixed Income

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  4. Investing Basics

    What is a Nominal Value?

    The nominal value of a security, such as a stock or bond, remains fixed for the duration of its life.
  5. Investing Basics

    Understanding Financial Instruments

    Financial instrument is a general term used to describe a monetary asset.
  6. Professionals

    Why You Should Avoid Fixating on Bond Duration

    Financial advisors and their clients should then focus on a bond fund’s portfolio rather than relying on any single metric like duration.
  7. Investing

    The Case For Stocks Today

    Last week, U.S. equities advanced with the S&P 500 Index notching new records. Investors are now getting nervous with rate and currency volatility spiking.
  8. Mutual Funds & ETFs

    Why You May Want To Be (And Stay) In Bonds

    Bonds are complicated, and it’s easy to feel intimidated or confused. Fortunately, you don’t need to be a numbers geek to be an informed investor.
  9. Mutual Funds & ETFs

    How To Short The U.S. Bond Market

    The U.S. bond market has enjoyed a strong bull run over the past few years as the Federal Reserve has lowered interest rates to historic low levels.
  10. Investing

    Why Some Investors Are Tilting Toward TIPS

    Last month’s five-year TIPS auction drew nearly $48 billion in interest, a sign of recent renewed demand for this inflation indexed asset among investors.

You May Also Like

Hot Definitions
  1. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  2. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  5. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  6. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
Trading Center