CPT CPT Fixed Income & Bond Trading 2

Question 1

What is the difference between a 'coupon bond' and a 'zero-coupon bond'?

Accepted Answer

A coupon bond pays periodic interest throughout its life; a zero-coupon bond pays no periodic interest and is sold at a deep discount to par

Answer

Zero-coupon bonds are issued at a discount and appreciate to par at maturity, providing return entirely through price appreciation rather than periodic income.

Question 2

What is 'convexity' in bond analysis, and why does it matter for large rate moves?

Accepted Answer

The curvature in the price-yield relationship showing that bond price increases more when rates fall than it decreases when rates rise by the same amount

Answer

Positive convexity means duration underestimates price gains when rates fall and overestimates losses when rates rise, making high-convexity bonds more valuable in volatile rate environments.

Question 3

What are 'investment-grade' bonds, and how are they distinguished from 'high-yield' (junk) bonds?

Accepted Answer

Investment-grade bonds are rated BBB-/Baa3 or above by major rating agencies; high-yield bonds are rated below that threshold and carry higher default risk

Answer

The BBB-/Baa3 rating is the dividing line — bonds above it are investment grade (lower yield, lower risk), while those below are high-yield (higher yield, higher default risk).

Question 4

How does the Federal Reserve's Federal Open Market Committee (FOMC) influence bond markets?

Accepted Answer

By setting the federal funds rate target, which anchors short-term rates and influences expectations for all maturities along the yield curve

Answer

The FOMC's rate decisions set the overnight lending rate benchmark, rippling through the yield curve as markets reprice expected future rates and inflation.

Question 5

What is a 'callable bond,' and what risk does it pose to investors?

Accepted Answer

A bond that can be redeemed by the issuer before maturity, typically when rates fall, exposing investors to reinvestment risk at lower yields

Answer

Issuers call bonds when rates drop to refinance at lower cost, forcing investors to reinvest proceeds at the new (lower) prevailing rates — this is reinvestment risk.

(CPT) Certified Pro Trader Practice Test

(CPT) Certified Pro Trader Practice Test

CPT CPT Fixed Income & Bond Trading 2