CFS CFS Fixed Income & Bonds 2 — Questions and Answers
Question 1: A zero-coupon bond is purchased at $600 and matures at $1,000 in 5 years. What best describes its return mechanism?
- It accretes to par value through amortization of the discount (Correct answer)
- It pays interest annually and returns par at maturity
- It adjusts its coupon rate based on market conditions
- It converts to equity at maturity
Correct answer: It accretes to par value through amortization of the discount
Zero-coupon bonds are issued at a discount and accrete to par value over time, with the difference representing the investor's return.
Question 2: Which bond type allows the investor to exchange the bond for shares of the issuer's stock?
- Convertible bond (Correct answer)
- Callable bond
- Putable bond
- Floating rate bond
Correct answer: Convertible bond
Convertible bonds give the holder the right to convert the bond into a specified number of the issuer's common shares.
Question 3: What is 'credit spread' in bond investing?
- The yield difference between a corporate bond and a comparable Treasury bond (Correct answer)
- The difference between bid and ask prices on a bond
- The gap between coupon rate and current yield
- The spread between short-term and long-term bond yields
Correct answer: The yield difference between a corporate bond and a comparable Treasury bond
Credit spread is the additional yield a corporate or non-Treasury bond offers above a comparable-maturity Treasury bond to compensate for credit risk.
Question 4: Which municipal bond type is backed by the full taxing authority of the issuing government entity?
- General obligation bond (Correct answer)
- Revenue bond
- Insured municipal bond
- Private activity bond
Correct answer: General obligation bond
General obligation bonds are backed by the issuer's unlimited taxing power, making them typically safer than revenue bonds.
Question 5: What does the term 'laddering' refer to in fixed income portfolio management?
- Purchasing bonds with staggered maturity dates (Correct answer)
- Buying only the highest-rated bonds available
- Concentrating investments in one maturity sector
- Selling bonds before their maturity date
Correct answer: Purchasing bonds with staggered maturity dates
Bond laddering involves buying bonds with different maturity dates to reduce interest rate risk and provide regular reinvestment opportunities.
Question 6: Convexity in bond analysis refers to:
- The curvature in the price-yield relationship beyond what duration captures (Correct answer)
- The linear relationship between bond prices and interest rates
- The shape of the yield curve at any given time
- The degree to which a bond's coupon compounds
Correct answer: The curvature in the price-yield relationship beyond what duration captures
Convexity measures the curvature of the price-yield relationship, providing a more accurate estimate of price changes when interest rate moves are large.
CFS CFS Fixed Income & Bonds 2
A zero-coupon bond is purchased at $600 and matures at $1,000 in 5 years.
What best describes its return mechanism?