CFA Fixed Income Analysis 1 — Questions and Answers
Question 1: A bond with a 5% annual coupon, $1,000 face value, and 10 years to maturity is priced at $950. The yield to maturity (YTM) is:
- Less than 5%
- Equal to 5%
- Greater than 5% (Correct answer)
- Cannot be determined without more information
Correct answer: Greater than 5%
When a bond trades at a discount (price below par), the YTM is higher than the coupon rate to compensate investors for the capital appreciation to par at maturity.
Question 2: Duration measures a bond's price sensitivity to changes in interest rates. If a bond has a modified duration of 7, a 1% increase in yield will cause the bond price to:
- Increase by approximately 7%
- Decrease by approximately 7% (Correct answer)
- Decrease by exactly 7%
- Increase by exactly 7%
Correct answer: Decrease by approximately 7%
Modified duration of 7 means a 1% rise in yield causes approximately a 7% decline in bond price; duration provides an approximation, not an exact figure.
Question 3: Which of the following bonds has the greatest price sensitivity to a change in interest rates?
- A 5-year bond with a 10% coupon
- A 10-year bond with a 10% coupon
- A 10-year bond with a 5% coupon (Correct answer)
- A 5-year bond with a 5% coupon
Correct answer: A 10-year bond with a 5% coupon
Longer maturity and lower coupon rate both increase duration and therefore price sensitivity; the 10-year, 5% coupon bond has the highest duration.
Question 4: Convexity in bond analysis refers to:
- The linear relationship between bond price and yield
- The curvature in the price-yield relationship that duration alone underestimates (Correct answer)
- The relationship between coupon rate and bond price
- The credit spread adjustment required for corporate bonds
Correct answer: The curvature in the price-yield relationship that duration alone underestimates
Convexity captures the curvature in the price-yield relationship, providing a more accurate estimate of price changes than duration alone for large yield moves.
Question 5: The nominal spread of a corporate bond is defined as:
- The difference between the bond's YTM and the spot rate of equal maturity
- The difference between the bond's YTM and the YTM of a benchmark government bond of similar maturity (Correct answer)
- The spread required to make the bond's present value equal to zero
- The option-adjusted spread net of embedded options
Correct answer: The difference between the bond's YTM and the YTM of a benchmark government bond of similar maturity
The nominal (or G-spread) is the simple difference between a corporate bond's YTM and a comparable maturity government benchmark YTM.
Question 6: A callable bond will have a price that is:
- Higher than an otherwise identical option-free bond at all yield levels
- Lower than an otherwise identical option-free bond because the call option benefits the issuer (Correct answer)
- The same as an option-free bond regardless of yield levels
- Higher than an option-free bond only when yields are rising
Correct answer: Lower than an otherwise identical option-free bond because the call option benefits the issuer
A callable bond is priced lower than an equivalent option-free bond because the embedded call option benefits the issuer at the expense of the investor.
CFA Fixed Income Analysis 1
A bond with a 5% annual coupon, $1,000 face value, and 10 years to maturity is priced at $950.
The yield to maturity (YTM) is: