CIM CIM Fixed Income & Debt Securities 1 — Questions and Answers
Question 1: When interest rates rise, the price of an existing fixed-rate bond will:
- Rise proportionally to the rate increase
- Remain unchanged because the coupon is fixed
- Fall, as new bonds offer higher yields making existing bonds less attractive (Correct answer)
- Double in value due to compounding effects
Correct answer: Fall, as new bonds offer higher yields making existing bonds less attractive
Bond prices and interest rates move inversely; when rates rise, existing bonds with lower coupons become less valuable relative to newly issued bonds.
Question 2: Duration is a fixed income concept that measures:
- The credit quality of the bond issuer
- A bond's price sensitivity to changes in interest rates (Correct answer)
- The time until the next coupon payment
- The spread between corporate and Treasury yields
Correct answer: A bond's price sensitivity to changes in interest rates
Duration quantifies how much a bond's price will change for a given change in interest rates, with higher duration indicating greater sensitivity.
Question 3: A yield curve is considered 'inverted' when:
- Short-term rates are higher than long-term rates (Correct answer)
- The curve slopes upward from left to right
- All maturities offer the same yield
- Long-term yields exceed short-term yields by more than 2%
Correct answer: Short-term rates are higher than long-term rates
An inverted yield curve, where short-term yields exceed long-term yields, is historically associated with an elevated probability of economic recession.
Question 4: A callable bond typically offers a higher yield than an otherwise identical non-callable bond because:
- Callable bonds have a lower credit rating by definition
- The issuer's right to redeem the bond early creates reinvestment risk for the investor (Correct answer)
- Callable bonds pay semiannual coupons while others pay quarterly
- Call provisions reduce the bond's liquidity on secondary markets
Correct answer: The issuer's right to redeem the bond early creates reinvestment risk for the investor
Investors demand a higher yield (call premium) on callable bonds to compensate for the risk that the issuer will redeem the bond early, typically when rates fall.
Question 5: Investment-grade bonds are generally defined as those rated:
- BB or below by Standard & Poor's
- BBB- or above by Standard & Poor's (Correct answer)
- AA or above by all major rating agencies
- Any bond issued by a publicly traded U.S. corporation
Correct answer: BBB- or above by Standard & Poor's
Investment-grade status is assigned to bonds rated BBB- or higher by S&P (Baa3 or higher by Moody's), indicating lower default risk.
Question 6: Convexity in bond analysis refers to:
- The linear relationship between bond price and coupon rate
- The curvature in the price-yield relationship, improving price estimates beyond duration alone (Correct answer)
- The tax treatment of bond discount amortization
- The correlation between two bonds' credit spreads
Correct answer: The curvature in the price-yield relationship, improving price estimates beyond duration alone
Convexity captures the non-linear aspect of how bond prices change with yield movements, providing a more accurate estimate than duration alone for large rate changes.
CIM CIM Fixed Income & Debt Securities 1
When interest rates rise, the price of an existing fixed-rate bond will: