Cushion Bond

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.

BREAKING DOWN '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. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Callable Bond

    A bond that can be redeemed by the issuer prior to its maturity. ...
  3. Coupon Rate

    The yield paid by a fixed income security. A fixed income security's ...
  4. Call Risk

    The risk, faced by a holder of a callable bond, that a bond issuer ...
  5. European Callable Bond

    A bond that can be redeemed by the issuer at a predetermined ...
  6. Reinvestment Rate

    The amount of interest that can be earned when money is taken ...
Related Articles
  1. Managing Wealth

    How To Evaluate Bond Performance

    Learn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
  2. Managing Wealth

    Bond Call Features: Don't Get Caught Off Guard

    Learn why early redemption occurs and how to avoid potential losses.
  3. ETFs & Mutual Funds

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  4. Markets

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  5. Markets

    How Does A Bond’s Coupon Interest Rate Affect Its Price?

    All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays.
  6. Markets

    The Effect of Fed Fund Rate Hikes on Your Bond Portfolio

    Learn how an increase in the federal funds rate may impact a bond portfolio. Read about how investors can use the duration of their portfolio to reduce risk.
  7. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  8. Markets

    How Rising Interest Rates Affect Junk Bonds

    We examine the impact of rising interest rates on higher-yielding bonds.
  9. Markets

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  10. Investing

    Explaining the Coupon Rate

    Coupon rate is the stated interest rate on a fixed income security.
RELATED FAQS
  1. How does a bond's coupon interest rate affect its price?

    Find out why the difference between the coupon interest rate on a bond and prevailing market interest rates has a large impact ... Read Answer >>
  2. Why do companies issue callable bonds?

    Learn how callable bonds work, how they include an embedded call option, and understand the additional risks that callable ... Read Answer >>
  3. What are the key factors that will cause a bond to trade as a premium bond?

    Learn about the primary factor that can cause bonds to trade at a premium, including how national interest rates affect bond ... Read Answer >>
  4. What risk factors should investors consider before purchasing a callable bond?

    Understand the difference between callable and non-callable bonds and consider all the various risk factors associated with ... Read Answer >>
  5. How does a bond's coupon rate affect its price?

    Find out how a bond's coupon rate influences its price, including the role of government-dictated interest rates and the ... Read Answer >>
  6. What causes a bond's price to rise?

    Learn about factors that influence the price of a bond, such as interest rate changes, credit rating, yield and overall market ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center