CFM CFM Fixed Income & Credit Analysis 2 — Questions and Answers
Question 1: What does a Z-spread represent in fixed income analysis?
- The constant spread added to the entire Treasury spot rate curve to equal a bond's price (Correct answer)
- The spread between zero-coupon bonds of different maturities
- The spread between bid and ask yield on a bond
- The yield difference between AAA and BBB bonds
Correct answer: The constant spread added to the entire Treasury spot rate curve to equal a bond's price
The Z-spread (zero-volatility spread) is added to each point on the spot rate curve to discount a bond's cash flows to its current market price.
Question 2: What does a flattening yield curve typically signal in fixed income markets?
- Slowing economic growth or potential recession expectations (Correct answer)
- Accelerating inflation and economic expansion
- Central bank cutting short-term rates aggressively
- Increased demand for short-term bonds only
Correct answer: Slowing economic growth or potential recession expectations
A flattening curve, where short-term rates rise toward long-term rates, often signals market concerns about future economic slowdown.
Question 3: What is a collateralized debt obligation (CDO)?
- A structured product that pools debt instruments and issues tranches with different risk/return profiles (Correct answer)
- A direct loan from a bank to a corporate borrower
- A government-guaranteed bond backed by mortgage loans
- A derivative contract referencing a basket of credit default swaps
Correct answer: A structured product that pools debt instruments and issues tranches with different risk/return profiles
A CDO pools various debt assets (loans, bonds, MBS) and repackages them into tranches ranging from senior (least risky) to equity (most risky).
Question 4: What is accrued interest on a bond?
- Interest earned since the last coupon payment that must be paid by the buyer at settlement (Correct answer)
- The total interest earned over a bond's entire life
- The difference between a bond's price and par value
- The interest rate used to discount future cash flows
Correct answer: Interest earned since the last coupon payment that must be paid by the buyer at settlement
When a bond is purchased between coupon dates, the buyer compensates the seller for interest accrued since the last coupon payment.
Question 5: How is yield to maturity (YTM) best defined?
- The single discount rate that equates a bond's cash flows to its current market price (Correct answer)
- The annualized coupon payment divided by par value
- The current coupon rate adjusted for inflation
- The average of all coupon payments received over the bond's life
Correct answer: The single discount rate that equates a bond's cash flows to its current market price
YTM is the internal rate of return of a bond investment assuming all coupons are reinvested at the same rate until maturity.
Question 6: What is negative convexity, commonly found in mortgage-backed securities (MBS)?
- Price gains are smaller than duration predicts when rates fall, due to prepayment risk (Correct answer)
- The bond always loses value regardless of rate movement
- Price changes exceed duration estimates in all rate environments
- The yield increases as rates decline
Correct answer: Price gains are smaller than duration predicts when rates fall, due to prepayment risk
When rates fall, homeowners prepay mortgages, shortening the MBS duration and limiting price appreciation — the opposite of the positive convexity seen in standard bonds.
CFM CFM Fixed Income & Credit Analysis 2
What does a Z-spread represent in fixed income analysis?