Premium paid for which bonds will be written off immediately to prevent a negative yield from being generated?

Question

Options

• APreventive holdings
• BDetective coupon
• CZero coupon convertible
• DAmortization rate

• A
  11% (6)
• B
  2% (1)
• C
  82% (46)
• D
  5% (3)

Explanation

Zero coupon convertible bonds carry no periodic coupon payments, so if purchased at a premium, there is no stream of interest income to absorb gradual premium amortization - spreading it out would produce a mathematically negative yield. To avoid this distortion, accounting standards require the premium to be written off immediately upon purchase, preserving a meaningful (non-negative) yield figure.

Why the distractors are wrong:

• A. Preventive holdings - not a recognized bond classification in fixed-income accounting; the term is fabricated.
• B. Detective coupon - likewise not a real financial instrument; it sounds like it was constructed to rhyme conceptually with the question.
• D. Amortization rate - this describes a method of spreading costs over time, not a bond type, and is actually the approach zero coupon bonds avoid when a premium is involved.

Memory tip: Link "zero coupon" to "zero tolerance for negative yields." Because there is no coupon to cushion the premium write-down over time, the premium must be eliminated all at once - zero coupon, zero delay.

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