Which type of cash flow does the flat yield method fail to account for?

The flat yield method is a simplified approach used to evaluate the yield of a bond based solely on its fixed coupon payments relative to its market price. This methodology assumes that the coupon payments remain constant over the life of the bond. However, it does not take into account varying bond coupons, which can occur for bonds that have different coupon rates due to various features such as step-up coupons, floating rates, or other contractual terms that might dictate changes in payment amounts over time.

Understanding this limitation is crucial for analysts and investors, as it can lead to misleading conclusions about a bond's potential yield and overall value if it does not acknowledge these variations in coupon payments. When assessing a bond investment, particularly those with complex structures, a more nuanced approach is necessary to capture the full range of expected cash flows.