CISI IAD Fixed Income Securities 2 — Questions and Answers
Question 1: What is 'convexity' in bond analysis?
- The curvature of the price-yield relationship that improves on the linear duration estimate (Correct answer)
- The spread between a bond's yield and the risk-free rate
- The average maturity of the bond's cash flows
- The inverse of the bond's modified duration
Correct answer: The curvature of the price-yield relationship that improves on the linear duration estimate
Convexity measures the curvature in the bond price–yield relationship; because duration is linear, convexity corrects for the error in large rate changes.
Question 2: A 'callable bond' gives which party the right to redeem the bond before maturity?
- The bondholder
- The issuer (Correct answer)
- The bond trustee
- The regulator
Correct answer: The issuer
A callable bond gives the issuer the right to redeem (call) the bond prior to maturity, typically when interest rates fall and the issuer can refinance more cheaply.
Question 3: The 'credit spread' on a corporate bond is best defined as:
- The difference between its bid and offer price
- The yield premium over a comparable maturity government bond (Correct answer)
- The annual coupon rate minus the risk-free rate
- The difference between the redemption yield and the flat yield
Correct answer: The yield premium over a comparable maturity government bond
The credit spread is the additional yield a corporate bond offers over a risk-free government bond of similar maturity, compensating for default risk.
Question 4: Which of the following statements about 'gilts' is correct?
- They are issued by UK local authorities
- They are UK government bonds issued by HM Treasury (Correct answer)
- They carry a significant risk of default
- They always pay a floating rate coupon
Correct answer: They are UK government bonds issued by HM Treasury
Gilts are UK government bonds issued by HM Treasury and are considered among the lowest credit-risk instruments available in sterling markets.
Question 5: Modified duration measures a bond's approximate price change for a:
- 1% change in the bond's coupon rate
- 1% (100 basis point) change in yield (Correct answer)
- One-year passage of time
- 1% change in the issuer's credit rating
Correct answer: 1% (100 basis point) change in yield
Modified duration estimates the percentage change in a bond's price for a 1% (100 basis point) change in its yield.
Question 6: What is a 'floating rate note' (FRN)?
- A bond whose maturity date can be extended by the issuer
- A bond whose coupon payments reset periodically based on a reference rate such as SONIA (Correct answer)
- A bond that can be converted into equity at the holder's option
- A bond that is traded on a floating exchange-rate basis
Correct answer: A bond whose coupon payments reset periodically based on a reference rate such as SONIA
An FRN pays periodic coupons that are reset at regular intervals based on a benchmark rate (e.g., SONIA + spread), reducing interest rate risk.
Question 7: A bond priced at a 'premium' means:
- Its yield to maturity is higher than its coupon rate
- Its market price is above its face (par) value (Correct answer)
- It has a higher credit rating than comparable bonds
- Its coupon is above the current risk-free rate only
Correct answer: Its market price is above its face (par) value
A bond trades at a premium when its market price exceeds par value, which occurs when its coupon rate is higher than prevailing market yields.
CISI IAD Fixed Income Securities 2
What is 'convexity' in bond analysis?