CPT CPT Fixed Income & Bond Trading 1 — Questions and Answers
Question 1: What is the fundamental inverse relationship between bond prices and interest rates?
- Bond prices and interest rates move in the same direction; rising rates cause prices to rise
- When interest rates rise, existing bond prices fall; when rates fall, bond prices rise (Correct answer)
- Bond prices are unaffected by interest rate changes after the initial issuance date
- Bond prices only react to short-term rate changes, not long-term Federal Reserve policy shifts
Correct answer: When interest rates rise, existing bond prices fall; when rates fall, bond prices rise
Because a bond's coupon is fixed, rising market rates make it less attractive relative to new bonds, so its price must fall to offer a competitive yield.
Question 2: What does 'duration' measure in bond portfolio management?
- The total years remaining until a bond matures from the current date
- A bond's price sensitivity to changes in interest rates, expressed in years (Correct answer)
- The average time since a bond was originally issued across all holdings
- The coupon payment frequency, expressed as the number of payments per year
Correct answer: A bond's price sensitivity to changes in interest rates, expressed in years
Duration quantifies how much a bond's price will change for a 1% shift in interest rates, with higher duration indicating greater price sensitivity.
Question 3: What is the 'yield curve,' and what does an inverted yield curve historically signal?
- A graph of bond yields vs. credit ratings; inversion signals a credit crisis is imminent
- A graph of yields across different maturities; inversion (short-term rates above long-term) has historically preceded recessions (Correct answer)
- A chart showing the yield spread between corporate and Treasury bonds; inversion signals tightening credit conditions
- A plot of a bond's yield over time since issuance; inversion indicates the bond was mispriced at launch
Correct answer: A graph of yields across different maturities; inversion (short-term rates above long-term) has historically preceded recessions
The yield curve plots yields for bonds of increasing maturity; an inversion where short-term rates exceed long-term rates has preceded most U.S. recessions historically.
Question 4: What does 'yield to maturity' (YTM) represent for a bond investor?
- The annual coupon rate stated on the bond's face at issuance
- The total annualized return an investor earns if the bond is held to maturity and all payments are reinvested at the same rate (Correct answer)
- The difference between the bond's purchase price and its par value at redemption
- The minimum yield required by credit rating agencies for investment-grade classification
Correct answer: The total annualized return an investor earns if the bond is held to maturity and all payments are reinvested at the same rate
YTM is the comprehensive annualized return that equates the bond's current price to the present value of all future cash flows, assuming reinvestment at the same rate.
Question 5: What is a 'Treasury bond futures contract,' and why do professional traders use it?
- A standardized agreement to buy or sell U.S. Treasury bonds at a set price on a future date, used for hedging interest rate exposure or speculating on rate moves (Correct answer)
- A forward contract issued by the U.S. Treasury to lock in government borrowing costs
- A structured product that pays the holder the difference between current and historical Treasury yields
- An exchange-traded fund tracking an index of investment-grade corporate bonds with Treasury collateral
Correct answer: A standardized agreement to buy or sell U.S. Treasury bonds at a set price on a future date, used for hedging interest rate exposure or speculating on rate moves
T-bond futures allow traders to gain leveraged exposure to or hedge against interest rate changes without owning the underlying bonds, trading on the CME Group.
Question 6: What is a 'credit spread' in fixed income markets?
- The difference in price between a new bond issuance and a previously issued bond from the same company
- The yield difference between a corporate bond and a comparable maturity Treasury bond, reflecting credit risk (Correct answer)
- The gap between a bond's bid price and ask price on the secondary market
- The premium paid on a bond callable above par compared to a non-callable equivalent
Correct answer: The yield difference between a corporate bond and a comparable maturity Treasury bond, reflecting credit risk
Credit spreads widen when investors demand more compensation for default risk and tighten when confidence in the issuer improves, making them a key risk indicator.
CPT CPT Fixed Income & Bond Trading 1
What is the fundamental inverse relationship between bond prices and interest rates?