CSC Fixed-Income Securities Analysis 3 — Questions and Answers
Question 1: Which of the following best describes a callable bond?
- A bond that can be redeemed by the investor before maturity at a set price
- A bond that can be redeemed by the issuer before maturity at a set price (Correct answer)
- A bond whose coupon rate adjusts with inflation
- A bond backed by a pool of mortgage loans
Correct answer: A bond that can be redeemed by the issuer before maturity at a set price
A callable bond gives the issuer the right to redeem the bond before its stated maturity date, typically at a premium to par.
Question 2: What happens to a bond's price when prevailing interest rates fall?
- The bond's price falls
- The bond's price rises (Correct answer)
- The bond's price remains unchanged
- The bond's coupon payment increases
Correct answer: The bond's price rises
Bond prices and interest rates move inversely; when rates fall, existing bonds with higher coupons become more valuable, so prices rise.
Question 3: Real Return Bonds (RRBs) issued by the Government of Canada protect investors against which specific risk?
- Default risk
- Currency risk
- Inflation risk (Correct answer)
- Liquidity risk
Correct answer: Inflation risk
RRBs adjust both principal and coupon payments based on the Consumer Price Index (CPI), protecting investors from purchasing power erosion due to inflation.
Question 4: A bond with a face value of $1,000 pays a 6% annual coupon. If the bond's current price is $1,060, what is its current yield?
- 6.00%
- 5.66% (Correct answer)
- 6.36%
- 5.00%
Correct answer: 5.66%
Current yield = annual coupon / current price = $60 / $1,060 = 5.66%.
Question 5: Which rating category marks the dividing line between investment-grade and non-investment-grade bonds under standard rating agency scales?
- AAA/Aaa
- A/A2
- BBB-/Baa3 (Correct answer)
- BB+/Ba1
Correct answer: BBB-/Baa3
BBB- (S&P/Fitch) or Baa3 (Moody's) is the lowest investment-grade rating; anything below is considered non-investment grade (high-yield or junk).
Question 6: What is the primary purpose of a bond sinking fund?
- To pay interest to bondholders on a quarterly basis
- To gradually retire a portion of the bond issue before final maturity (Correct answer)
- To insure the bond against issuer default
- To allow bondholders to convert bonds into equity
Correct answer: To gradually retire a portion of the bond issue before final maturity
A sinking fund requires the issuer to set aside money periodically to retire portions of the bond issue, reducing default risk at final maturity.
Question 7: Which measure accounts for the possibility that a callable bond will be redeemed early by the issuer?
- Current yield
- Yield to maturity
- Yield to call (Correct answer)
- Coupon yield
Correct answer: Yield to call
Yield to call calculates the bond's yield assuming it is called on the earliest possible call date, rather than held until final maturity.
CSC Fixed-Income Securities Analysis 3
Which of the following best describes a callable bond?