CISI IAD Fixed Income Securities 1 — Questions and Answers
Question 1: What is the relationship between bond prices and interest rates?
- They move in the same direction
- They move in opposite directions (Correct answer)
- They are unrelated
- They only correlate for government bonds
Correct answer: They move in opposite directions
Bond prices and interest rates have an inverse relationship: when rates rise, existing bond prices fall because newer bonds offer higher yields.
Question 2: A bond with a face value of £1,000, a coupon rate of 5% and a current market price of £950 has a current yield of approximately:
- 5.00%
- 5.26% (Correct answer)
- 4.75%
- 5.50%
Correct answer: 5.26%
Current yield = Annual coupon / Market price = £50 / £950 = 5.26%.
Question 3: Which of the following best describes 'duration' in the context of fixed income securities?
- The number of years until the bond matures
- A measure of a bond's sensitivity to interest rate changes (Correct answer)
- The average time until principal repayment only
- The coupon payment frequency
Correct answer: A measure of a bond's sensitivity to interest rate changes
Duration measures a bond's price sensitivity to changes in interest rates; a higher duration means greater price volatility for a given rate move.
Question 4: A 'zero coupon bond' is best described as:
- A bond that pays no interest and is issued at par
- A bond issued at a discount that pays no periodic interest (Correct answer)
- A bond with a variable coupon that can fall to zero
- A government bond with a zero credit risk
Correct answer: A bond issued at a discount that pays no periodic interest
Zero coupon bonds are issued at a discount to face value and pay no periodic coupons; the investor's return comes entirely from the accretion to par at maturity.
Question 5: Which type of UK government bond is designed to protect investors against inflation?
- Conventional gilts
- Index-linked gilts (Correct answer)
- Undated gilts
- Treasury bills
Correct answer: Index-linked gilts
Index-linked gilts have both their coupon payments and principal linked to the UK Retail Prices Index (RPI), providing inflation protection.
Question 6: What does 'yield to maturity' (YTM) represent for a bond?
- The coupon rate stated on the bond certificate
- The total annualised return if the bond is held until maturity and coupons are reinvested at the same rate (Correct answer)
- The current income yield based on market price
- The yield on a comparable risk-free government bond
Correct answer: The total annualised return if the bond is held until maturity and coupons are reinvested at the same rate
YTM is the internal rate of return on a bond, assuming it is held to maturity and all coupon payments are reinvested at the same rate.
Question 7: Which credit rating is considered the lowest investment-grade rating by Standard & Poor's?
- AA-
- A-
- BBB- (Correct answer)
- BB+
Correct answer: BBB-
BBB- is the lowest investment-grade rating from S&P; bonds rated BB+ and below are classified as speculative or 'high yield'.
CISI IAD Fixed Income Securities 1
What is the relationship between bond prices and interest rates?