2.4 Bond Features and Risks

Series 7 General Securities Representative

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1 Introduction

About the Series 7 How to Use This Guide

2 Chapter 1: Equity Securities

1.1 Common Stock Basics 1.2 Dividends and Stock Splits 1.3 Preferred Stock 1.4 Rights and Warrants 1.5 ADRs and Foreign Securities

3 Chapter 2: Debt Securities

2.1 Bond Fundamentals 2.2 Bond Yields and Pricing 2.3 Corporate Bonds 2.4 Bond Features and Risks

4 Chapter 3: U.S. Government & Agency Securities

3.1 Treasury Securities 3.2 Agency Securities 3.3 Mortgage-Backed Securities 3.4 Money Market Instruments

5 Chapter 4: Municipal Securities

4.1 Municipal Bond Basics 4.2 General Obligation Bonds 4.3 Revenue Bonds 4.4 Municipal Bond Analysis 4.5 Municipal Securities Rules

6 Chapter 5: Investment Companies

5.1 Investment Company Basics 5.2 Mutual Funds (Open-End Funds) 5.3 Mutual Fund Pricing and Fees 5.4 Closed-End Funds and ETFs 5.5 Investment Company Taxation

7 Chapter 6: Variable Products & Annuities

6.1 Annuity Basics 6.2 Variable Annuities 6.3 Annuity Taxation 6.4 Variable Life Insurance

8 Chapter 7: Alternative Investments & DPPs

7.1 Direct Participation Program Basics 7.2 Types of DPPs 7.3 DPP Suitability and Risks 7.4 Real Estate Investment Trusts (REITs) 7.5 Hedge Funds and Other Alternatives

9 Chapter 8: Options

8.1 Options Basics 8.2 Long and Short Option Positions 8.3 Hedging Strategies 8.4 Spreads and Combinations 8.5 Index and Non-Equity Options 8.6 Options Account Requirements

10 Chapter 9: Customer Accounts

9.1 Account Types 9.2 Cash Accounts 9.3 Margin Accounts 9.4 Margin Calculations 9.5 Fiduciary and Institutional Accounts

11 Chapter 10: Retirement & Education Plans

10.1 ERISA and Qualified Plans 10.2 Defined Benefit vs. Defined Contribution 10.3 Individual Retirement Accounts 10.4 Education Savings Plans 10.5 Plan Distributions and Taxation

12 Chapter 11: Securities Markets & Trading

11.1 The Primary Market 11.2 The Secondary Market 11.3 Order Types and Execution 11.4 Trade Settlement and Reporting 11.5 Market Participants

13 Chapter 12: Rules, Regulations & Ethics

12.1 Regulatory Framework 12.2 Suitability Requirements 12.3 Communications with the Public 12.4 Prohibited Activities 12.5 Customer Protection Rules 12.6 Ethics and Professional Conduct

2.4 Bond Features and Risks

Key Takeaways Explain This Topic AI

Callable bonds benefit issuers and create call and reinvestment risk for investors.

Put provisions benefit investors and reduce downside price risk.

Sinking funds reduce default risk but add refunding risk.

Bond risks include interest rate, credit, inflation, and liquidity risk.

Callable bonds generally pay higher coupons; putable bonds pay lower coupons.

Last updated: June 2026

Call Provisions

A call provision lets the issuer redeem a bond before maturity at a set price. Issuers call when rates fall — they retire high-coupon debt and refinance cheaper, exactly like refinancing a mortgage.

Term Definition
Call price Price paid to redeem (par + call premium)
Call premium Amount above par (often one year's interest)
Call protection Years during which the bond cannot be called
Call date First date the issuer may call

Example: A bond with 5-year call protection cannot be called for 5 years; afterward the issuer may redeem at $1,050 (par + $50 premium). Calls hurt investors: they lose a high-yielding holding, must reinvest at lower rates, and the call price caps upside. To compensate, callable bonds carry higher coupons than otherwise-identical non-callable bonds. Call risk is greatest for premium bonds.

Put Provisions

A put provision lets the bondholder sell the bond back to the issuer at par before maturity. It protects investors when rates rise : put the bond back at par and reinvest at higher rates, which limits downside price risk. Because the feature favors the investor, putable bonds carry lower coupons . Call benefits the issuer; put benefits the investor — a guaranteed exam contrast.

Sinking Fund Provisions

A sinking fund requires the issuer to set aside money to retire part of the issue periodically. The issuer either buys bonds in the open market (when they trade below par) or calls them by lottery at par (when above par). Sinking funds reduce default risk because debt is repaid gradually, but they create refunding/call risk for the holder whose bond may be retired early.

The Six Core Bond Risks
Interest Rate Risk

The risk that rising rates lower a bond's market value. Longer maturity and lower coupon both increase sensitivity; duration quantifies it. A 20-year 4% bond is far more volatile than a 5-year 8% bond.

Factor Effect on interest rate risk
Longer maturity Higher
Lower coupon Higher
Lower yield Higher
Credit (Default) Risk

The risk the issuer misses interest or principal. The credit spread — a corporate yield minus a comparable Treasury yield — widens as perceived risk rises. Treasuries are considered free of credit risk.

Reinvestment Risk

The risk that coupons or returned principal cannot be reinvested at the original rate. Highest when rates are falling , coupons are high, and bonds are callable or have sinking funds. Zero-coupon bonds have no reinvestment risk because there are no interim coupons to reinvest — a favorite exam point.

Call Risk

A form of reinvestment risk specific to callable bonds: the investor gets principal back early and must reinvest at lower rates, losing remaining scheduled interest. Greatest for premium bonds when rates drop.

Inflation (Purchasing Power) Risk

The risk that inflation erodes the real value of fixed payments. Worst for long-term, fixed-rate bonds. Treasury Inflation-Protected Securities (TIPS) hedge this by adjusting principal with the Consumer Price Index, so both the inflation-adjusted principal and the semiannual coupon (a fixed rate on rising principal) grow with inflation.

Liquidity (Marketability) Risk

The risk of not selling quickly at a fair price. Treasuries and large, recent corporate issues are highly liquid; small municipal and high-yield issues are less so. Thin markets force a seller to accept a lower price or wait, widening the bid-ask spread the client effectively pays.

Legislative, Political, and Currency Risk

The exam also recognizes secondary risks worth naming. Legislative risk is the chance that a change in law — for example, a cut to a municipal bond's tax exemption — reduces a bond's value. Political (sovereign) risk applies to foreign government bonds whose value can fall with instability. Currency (exchange-rate) risk affects bonds denominated in a foreign currency: even a sound issuer can disappoint a U.S. investor if the foreign currency weakens against the dollar. These rarely dominate a question but appear as distractors and in suitability scenarios for international holdings.

Matching Features and Risks to the Client

The practical skill the exam rewards is connecting a feature to the risk it creates and then to a suitable client. A retiree seeking dependable income dislikes call risk, so a non-callable or putable bond suits her better than a premium callable bond that may be redeemed just as rates fall. An investor worried about inflation over a long horizon is steered toward TIPS. An investor who needs to liquidate on short notice should avoid thinly traded high-yield or small municipal issues. Tie each recommendation back to the client's objective, time horizon, and risk tolerance — the recurring logic behind nearly every features-and-risks question.

Risk Summary

Risk Definition Driven by
Interest rate Price falls when rates rise Maturity, coupon
Credit/default Issuer fails to pay Issuer financial health
Reinvestment Cannot reinvest at same rate Falling rates, high coupon
Call Bond called early Falling rates, callable bonds
Inflation Purchasing power erosion Fixed payments, long maturity
Liquidity Hard to sell at fair price Issue size, market depth
On the Exam

Know who each feature benefits (call = issuer, put = investor), that call risk is a form of reinvestment risk concentrated in premium bonds, that zero-coupon bonds eliminate reinvestment risk, that TIPS hedge inflation, and that longer maturity plus lower coupon maximize interest rate risk.