The first step in valuation process is to estimate the cash flows that are expected to be received in the future. In debt securities, there are two types of possible cash flow: Interest and principal repayment. The estimation of cash flow is not easy excluding few securities such as government-dated securities. Government dated securities have known interest payments, so estimating cash flow becomes very easy for these kinds of securities. However, there are securities coming with different types of options; estimating cash flow for these securities is a little difficult. Examples of these kinds of securities are as follows:
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Securities with an option to issuer or investor, to change the contractual due date of repayment of principal. For example, Callable bonds, Putable bonds, Asset-backed securities and Mortgage-backed securities.
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Securities in which coupon payment is fixed periodically based on a formula that depend on some reference rates, prices or exchange rates. For example, Floating-Rate Securities etc.
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Securities that give choice to the investor to convert the securities into shares. For example, convertible bonds, exchangeable bonds etc.