CFM CFM Fixed Income & Credit Analysis 1 — Questions and Answers
Question 1: What is the fundamental relationship between bond prices and interest rates?
- Bond prices move inversely to interest rates (Correct answer)
- Bond prices move in the same direction as interest rates
- Bond prices are unaffected by interest rates
- Bond prices only change at maturity
Correct answer: Bond prices move inversely to interest rates
When interest rates rise, existing bond prices fall because new bonds offer higher yields, making older bonds less attractive.
Question 2: Which measure quantifies the weighted average time to receive a bond's cash flows?
- Duration (Correct answer)
- Convexity
- Yield to maturity
- Coupon rate
Correct answer: Duration
Duration measures the weighted average time to receive all cash flows and is used as a proxy for interest rate sensitivity.
Question 3: What is a credit default swap (CDS) primarily used for?
- Hedging credit risk on a reference entity (Correct answer)
- Paying fixed coupons on a bond
- Converting floating rates to fixed rates
- Increasing duration of a portfolio
Correct answer: Hedging credit risk on a reference entity
A CDS is a derivative contract where the protection buyer pays periodic premiums in exchange for compensation if a credit event occurs on the reference entity.
Question 4: What does positive convexity indicate about a bond's price-yield relationship?
- Price increases more than duration predicts when rates fall, and decreases less when rates rise (Correct answer)
- Price changes are perfectly linear with rate changes
- Price always increases regardless of rate movement
- The bond pays higher coupons when rates rise
Correct answer: Price increases more than duration predicts when rates fall, and decreases less when rates rise
Positive convexity means the price-yield curve is curved such that price gains exceed duration-estimated gains in falling rate environments.
Question 5: What is the credit spread in fixed income markets?
- The yield difference between a corporate bond and a comparable Treasury bond (Correct answer)
- The difference between a bond's coupon and its yield to maturity
- The gap between bid and ask prices on a bond
- The spread between short-term and long-term government rates
Correct answer: The yield difference between a corporate bond and a comparable Treasury bond
The credit spread compensates investors for taking on credit risk above the risk-free rate represented by Treasury bonds.
Question 6: Which rating category do Moody's, S&P, and Fitch classify as 'investment-grade'?
- Baa3/BBB- and above (Correct answer)
- Ba1/BB+ and above
- Caa/CCC and above
- A1/A+ and above only
Correct answer: Baa3/BBB- and above
Investment-grade bonds are rated Baa3/BBB- or higher, indicating adequate capacity to meet financial commitments.
CFM CFM Fixed Income & Credit Analysis 1
What is the fundamental relationship between bond prices and interest rates?