LOS b: Identify the types of bonds for which estimating the expected cash flows is difficult and explain the problems encountered when estimating the cash flows for these bonds.

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.

 

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.