CSC Fixed-Income Securities Analysis 2 — Questions and Answers
Question 1: A bond's duration measures which of the following?
- The time until the bond's first coupon payment
- The weighted average time to receive the bond's cash flows (Correct answer)
- The difference between the bond's coupon rate and yield
- The number of years until the bond can be called
Correct answer: The weighted average time to receive the bond's cash flows
Duration is the weighted average time to receive all cash flows (coupons and principal), weighted by their present values.
Question 2: If a bond has a modified duration of 5 and market yields rise by 1%, what is the approximate change in the bond's price?
- +5%
- -1%
- -5% (Correct answer)
- +1%
Correct answer: -5%
Modified duration approximates that a 1% rise in yield causes a price decline roughly equal to the modified duration percentage, so approximately -5%.
Question 3: Which type of bond carries the highest credit risk?
- Government of Canada bonds
- Provincial bonds
- Investment-grade corporate bonds
- High-yield (junk) bonds (Correct answer)
Correct answer: High-yield (junk) bonds
High-yield bonds, also called junk bonds, are rated below investment grade and carry the highest risk of default among these choices.
Question 4: What does a flat yield curve indicate about market expectations?
- Investors expect significantly higher future interest rates
- Investors expect significantly lower future interest rates
- Investors have little expectation of interest rate changes (Correct answer)
- Investors expect a sharp economic recession
Correct answer: Investors have little expectation of interest rate changes
A flat yield curve, where short- and long-term rates are similar, suggests the market has little consensus or expectation of significant future rate changes.
Question 5: An investor buys a strip bond at a deep discount. How is the investment return realized?
- Through semi-annual coupon payments
- Through the difference between the purchase price and face value at maturity (Correct answer)
- Through quarterly dividend distributions
- Through annual interest payments from the issuer
Correct answer: Through the difference between the purchase price and face value at maturity
Strip bonds pay no coupons; the investor's return comes entirely from the appreciation of the purchase price to face value at maturity.
Question 6: Which term describes the risk that a bond investor cannot reinvest coupon payments at the same rate as the original yield?
- Credit risk
- Liquidity risk
- Reinvestment risk (Correct answer)
- Call risk
Correct answer: Reinvestment risk
Reinvestment risk is the risk that future coupon payments will be reinvested at lower rates than originally anticipated, reducing total return.
Question 7: What is the relationship between a bond's coupon rate and its price when it trades at a discount?
- Coupon rate equals the yield to maturity
- Coupon rate is higher than the yield to maturity
- Coupon rate is lower than the yield to maturity (Correct answer)
- Coupon rate is unrelated to the bond's price
Correct answer: Coupon rate is lower than the yield to maturity
A bond trades at a discount when its coupon rate is lower than the prevailing yield to maturity, making it less attractive at par.
CSC Fixed-Income Securities Analysis 2
A bond's duration measures which of the following?