CFA Fixed Income Analysis 2 — Questions and Answers
Question 1: A bond with a 6% coupon is priced at a yield of 5%. If the yield increases by 100 bps, the price will:
- Increase by approximately the modified duration percentage
- Decrease by approximately the modified duration percentage (Correct answer)
- Remain unchanged because coupon rate exceeds yield
- Decrease by exactly 1%
Correct answer: Decrease by approximately the modified duration percentage
When yields rise, bond prices fall by approximately modified duration × yield change.
Question 2: Which of the following bonds has the greatest reinvestment risk?
- Zero-coupon bond maturing in 10 years
- 5% coupon bond maturing in 10 years
- 10% coupon bond maturing in 10 years (Correct answer)
- Floating-rate note maturing in 10 years
Correct answer: 10% coupon bond maturing in 10 years
Higher coupon bonds have greater reinvestment risk because more cash flows must be reinvested at potentially different rates.
Question 3: The Z-spread is best described as the constant spread added to:
- Each Treasury spot rate to equal the bond's YTM
- The par yield curve to price the bond at par
- Each Treasury spot rate to discount cash flows to the market price (Correct answer)
- The swap curve to equal the bond's credit spread
Correct answer: Each Treasury spot rate to discount cash flows to the market price
The Z-spread is added to each spot rate on the benchmark Treasury curve so that the PV of cash flows equals the bond's market price.
Question 4: A callable bond's option-adjusted spread (OAS) versus its Z-spread will typically show:
- OAS > Z-spread because the call option benefits the issuer
- OAS = Z-spread because options don't affect spread
- OAS < Z-spread because the call option premium reduces the spread (Correct answer)
- OAS > Z-spread because the call option compensates investors
Correct answer: OAS < Z-spread because the call option premium reduces the spread
For a callable bond, OAS < Z-spread because the Z-spread includes the value of the embedded call option that benefits the issuer.
Question 5: A bond with convexity of 120 and modified duration of 8 will experience a price change closest to which value if yields rise by 200 bps?
- -16.00%
- -15.76% (Correct answer)
- -14.56%
- -13.20%
Correct answer: -15.76%
Price change ≈ -Duration × Δy + 0.5 × Convexity × (Δy)² = -8(0.02) + 0.5(120)(0.02)² = -16% + 0.24% = -15.76%.
Question 6: Which of the following best describes the liquidity preference theory of the term structure?
- Long-term rates equal the average of expected future short-term rates
- Investors demand a premium for holding longer-term bonds due to greater price risk (Correct answer)
- Supply and demand for bonds at each maturity independently determine rates
- Forward rates are unbiased predictors of future spot rates
Correct answer: Investors demand a premium for holding longer-term bonds due to greater price risk
Liquidity preference theory holds that investors require a liquidity premium for bearing the price risk of longer-maturity bonds.
Question 7: An investor buys a 3-year bond at par with a 5% annual coupon. If the bond is sold after 2 years when the yield is 4%, the holding period return is closest to:
- 5.00%
- 5.47% (Correct answer)
- 6.12%
- 7.21%
Correct answer: 5.47%
The investor receives two coupons of 5 and sells for approximately 100.96 (1 year 5% cash flow discounted at 4%), giving an HPR slightly above the coupon rate.
CFA Fixed Income Analysis 2
A bond with a 6% coupon is priced at a yield of 5%.
If the yield increases by 100 bps, the price will: