CFA Level I Exam · Fixed-Income Cash Flows and Types

Coupon Payment Structures for CFA Level I

Updated 7 October 2026 · Fact-checked

A coupon structure is the rule that sets the interest a bond pays. Fixed-rate bonds pay a set rate. Floating-rate notes pay reference rate plus spread. Zero-coupon bonds pay none and sell at a discount. Step-up, deferred, PIK and index-linked bonds change the rate or form of payment. Identify the rule, then apply it to the period.

Understand Coupon Payment Structures

A bond's coupon is the interest the issuer pays, usually a percentage of par (face value). The coupon structure tells you how that percentage is set and when it is paid. Exam questions test whether you can read the rule and compute the cash flow.

A fixed-rate bond pays the same coupon rate every period. A floating-rate note (FRN) pays a reference rate (such as SOFR or Euribor) plus a spread (also called quoted margin). The rate resets each period, so the coupon moves with market rates. Many FRNs are set at the start of a period and paid at its end. FRNs can have a cap (maximum rate) or a floor (minimum rate). An inverse floater pays a coupon that moves opposite to the reference rate.

A zero-coupon bond pays no coupon. You buy at a discount and receive par at maturity, so all return is the price gain. A step-up coupon bond has a coupon that rises on pre-set dates, by a set amount or to a set rate. A deferred coupon bond (or split-coupon) pays no coupon for the first years and then pays a higher coupon. A payment-in-kind (PIK) bond lets the issuer pay the coupon with more bonds instead of cash, which increases the principal owed.

Index-linked bonds tie payments to an index, often consumer prices. A capital-indexed bond pays a fixed coupon rate, but the principal is adjusted by inflation, so the coupon amount rises because it is applied to the adjusted principal. An interest-indexed bond keeps the principal fixed and adjusts the coupon for inflation: the coupon is (coupon rate + inflation adjustment) × original par, and original par is repaid unchanged. An indexed-annuity bond pays a level amount that includes interest and principal, adjusted for inflation. Treasury inflation-protected securities (TIPS) are capital-indexed. Some designs protect against deflation with a par floor on principal at maturity.

Key formulas to remember

FRN coupon rate: Coupon rate = reference rate + quoted margin; Use the annual rate, then divide by periods per year for the period coupon.
FRN coupon payment: Coupon = par × (reference rate + quoted margin) ÷ periods per year; Check whether the reference rate is quoted annually. A 6-month rate stated as annual still needs ÷ 2.
Fixed coupon payment: Coupon = par × coupon rate ÷ periods per year; Semiannual is the common exam case.
Zero-coupon bond price: Price = par ÷ (1 + r)^n; r is the periodic yield and n the number of periods. Return comes only from the discount. The return itself is r = (par ÷ price)^(1/n) − 1.
Capital-indexed bond: Adjusted principal = par × (1 + inflation); coupon = coupon rate × adjusted principal; Principal and coupon both rise with inflation when the coupon rate is fixed.
Interest-indexed bond: Coupon = (coupon rate + inflation adjustment) × original par; Principal repaid is the original par, unchanged.
PIK principal growth: New principal = old principal × (1 + coupon rate ÷ periods per year); Applies when the coupon is paid in additional bonds.

How to solve Coupon Payment Structures questions

Use the same sequence for any coupon-structure question. It stops you applying the wrong rule.

1Name the structure from the wording: fixed, floating, zero, step-up, deferred, PIK, or index-linked (capital or interest).
2Write down par, payment frequency and the period being asked about.
3For an FRN, add the reference rate and the spread, then divide by periods per year.
4For an indexed bond, find what is adjusted: principal (capital-indexed) or the coupon (interest-indexed).
5Apply the adjustment to the correct base, in the correct period, using the right rate for that period.
6Check whether the answer is a cash payment or an accrual (PIK adds principal, zero pays none).
7Sanity-check direction: rates up means FRN coupon up, inflation up means indexed payments up.

Quickest way: Rule-first shortcut

When to use it: Use it for three-option MCQs where the structure is named and one calculation is needed.

Underline the structure word and the reset rate.
Convert the annual rate to the period rate first.
Compute the coupon once, then compare with the three options, which are ordered smallest to largest.
Eliminate options that use the wrong base (original par instead of adjusted principal) or forget the period split.
If conceptual, ask who bears the risk: floating protects against rising rates, indexed protects against inflation, PIK and deferred raise credit risk.

Common mistakes in Coupon Payment Structures

Forgetting to divide the annual FRN rate by the number of periods.
The reference rate and spread are quoted per year, so the sum looks like the coupon.
Fix: Always write the periods per year and divide before multiplying by par.
Using the reference rate from the payment date instead of the reset date.
Students assume the coupon uses the latest rate.
Fix: The coupon uses the reference rate set at the beginning of the period (in advance) and is paid at the end of the period (in arrears). Use the rate set at the start of the period, not the rate on the payment date.
Confusing capital-indexed and interest-indexed bonds.
Both are called inflation-linked and both raise payments.
Fix: Ask what changes: principal (capital-indexed, coupon rate stays fixed) or the coupon itself (interest-indexed, principal stays fixed).
Calling a step-up bond the same as a deferred coupon bond.
Both have lower early income and higher later income.
Fix: Step-up pays a coupon from the start that rises. Deferred pays no coupon at first.
Thinking a PIK bond pays nothing and carries no interest cost.
No cash leaves the issuer in the period.
Fix: Interest accrues as extra principal, so debt grows and the investor holds more bonds.
Treating a zero-coupon bond as having zero return.
The word zero suggests no income.
Fix: Return is the gap between discounted price and par, earned at maturity.

Worked examples

Example 1

A €1,000 par FRN pays semiannual coupons at 6-month Euribor + 0.80%. For the next period, the annualized 6-month Euribor is 3.20%. What is the coupon payment? A) €16.00 B) €20.00 C) €40.00

Show the solution

Annual coupon rate = 3.20% + 0.80% = 4.00%.
Semiannual rate = 4.00% ÷ 2 = 2.00%.
Coupon = €1,000 × 2.00% = €20.00.
Option C (€40.00) forgets to divide by 2. Option A (€16.00) uses only 3.20% ÷ 2.

Answer: B) €20.00

Example 2

A capital-indexed bond has par $1,000 and a fixed 2% annual coupon. Inflation over the year is 3%. What is the coupon paid at year end, applied to the inflation-adjusted principal? A) $20.00 B) $20.60 C) $50.00

Show the solution

Adjusted principal = $1,000 × 1.03 = $1,030.
Coupon = 2% × $1,030 = $20.60.
Option A uses unadjusted par. Option C wrongly adds 2% and 3% to get 5% and applies it to par ($1,000 × 5% = $50).

Answer: B) $20.60

Exam tips

Read what is held fixed: in capital-indexed bonds the coupon rate is fixed, but the coupon amount still rises.
For FRNs, check if the spread is stated in percent or basis points. 80 bps = 0.80%.
Know the credit angle: PIK and deferred coupon structures usually signal weaker cash flow for the issuer.
Know the rate view: an FRN's price stays close to par at reset dates because the coupon follows market rates.
With no penalty for wrong answers, always answer. Eliminate options that skip the period split or use unadjusted par.

Practice questions from Fixed-Income Cash Flows and Types

Coupon Payment Structures: frequently asked questions

What is the FRN coupon formula for CFA Level I?

Coupon rate = reference rate + quoted margin. The period coupon is par × that rate ÷ periods per year. For example, 4% on €1,000 paid semiannually gives €20.

What is the difference between zero-coupon and step-up bonds?

A zero-coupon bond pays no coupon and is sold at a discount to par. A step-up bond pays coupons from the start, and the rate rises on set dates.

Capital-indexed versus interest-indexed bonds: what is the difference?

A capital-indexed bond adjusts the principal for inflation and applies a fixed coupon rate to it. An interest-indexed bond keeps the principal fixed and adjusts the coupon.

What is a payment-in-kind bond?

A PIK bond lets the issuer pay the coupon with additional bonds rather than cash. The issuer conserves cash while debt outstanding grows, so credit risk for the investor is typically higher.