What, exactly, does “otherwise similar” mean in this context?
Where did you get this question?
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idk i don`t got it too, I got this question in the CFA book, it was a blue box example in Reading 42.
I read the question in the curriculum. “Otherwise similar” apparently means that the initial principals are equal, the maturities are equal, the payment frequencies are equal, and the interest rates are equal. The periodic payments are, therefore, different.
Of course, you could also have equal periodic payments and different interest rates.
Simple example: borrow USD 100 for one year at 6% interest, payable every 6 months. The partially amortized bond has a balloon payment of USD 50.
Fully amortized bond:
- Payment: USD 52.26
- 6-month payment:
- Interest: USD 3.00
- Principal: USD 49.26
- Remaining balance: USD 50.74
- 12-month payment:
- Interest: USD 1.52
- Principal: USD 50.74
- Remaining balance: USD 0.00
Partially amortized bond:
- Payment: USD 27.63
- 6-month payment:
- Interest: USD 3.00
- Principal: USD 24.63
- Remaining balance: USD 75.37
- 12-month payment:
- Interest: USD 2.26
- Principal: USD 25.37
- Remaining balance: USD 50.00
The first interest payment on the partially amortized bond is the same as the first interest payment on the fully amortized bond, and the second interest payment on the partially amortized bond is higher than the second interest payment on the fully amortized bond.
Apparently when they say “coupon”, they mean the interest portion of the principal-and-interest payment.
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Thx for the explanation, I hope to don`t get a question like this in the exam, the wording they used made it very confusing lol