FIA Fixed Income & Bond Markets 5 — Questions and Answers
Question 1: Which risk describes the possibility that coupon payments cannot be reinvested at a rate equal to the bond's YTM?
- Call risk
- Reinvestment risk (Correct answer)
- Extension risk
- Liquidity risk
Correct answer: Reinvestment risk
Reinvestment risk occurs when interim coupon cash flows must be reinvested at lower prevailing rates, reducing total realized return below the stated YTM.
Question 2: What is the spread between a corporate bond's yield and an on-the-run Treasury of the same maturity called?
- OAS
- Credit spread (or yield spread) (Correct answer)
- DV01
- Swap spread
Correct answer: Credit spread (or yield spread)
The credit spread (yield spread) reflects compensation for credit risk, liquidity risk, and other factors above the risk-free Treasury rate.
Question 3: Extension risk in mortgage-backed securities (MBS) occurs when:
- Prepayments accelerate beyond expectations
- Rising rates cause homeowners to prepay mortgages faster
- Rising rates slow prepayments, extending the MBS duration beyond expectations (Correct answer)
- The MBS issuer calls the security early
Correct answer: Rising rates slow prepayments, extending the MBS duration beyond expectations
When rates rise, refinancing activity slows, fewer mortgages are prepaid, and MBS investors receive principal more slowly than expected—extending effective duration.
Question 4: Which term describes bonds issued in a currency different from that of the country where they are issued?
- Foreign bonds
- Eurobonds (Correct answer)
- Sovereign bonds
- Samurai bonds
Correct answer: Eurobonds
Eurobonds are issued in a currency other than that of the country where they are sold (e.g., a USD-denominated bond sold in Europe).
Question 5: What does the term 'on-the-run' refer to in the Treasury market?
- Treasuries currently under SEC investigation
- The most recently issued Treasury security of a given maturity (Correct answer)
- Treasuries with the highest outstanding volume
- Short-duration Treasuries maturing within 90 days
Correct answer: The most recently issued Treasury security of a given maturity
On-the-run Treasuries are the most recently auctioned securities for each maturity, making them the most liquid and actively traded benchmark issues.
Question 6: A bond's 'yield to worst' (YTW) is defined as:
- The yield assuming the bond defaults immediately
- The lowest potential yield across all possible call, put, or maturity scenarios (Correct answer)
- The yield calculated using the worst-case credit spread
- The yield if the bond is held to its first call date
Correct answer: The lowest potential yield across all possible call, put, or maturity scenarios
YTW is the minimum yield an investor can earn, calculated across all possible redemption scenarios (calls, puts, or maturity)—a conservative yield measure.
Question 7: Which market participant is typically the primary dealer responsible for underwriting new U.S. Treasury securities?
- Hedge funds
- Primary dealers designated by the Federal Reserve Bank of New York (Correct answer)
- Municipal bond issuers
- Insurance companies
Correct answer: Primary dealers designated by the Federal Reserve Bank of New York
Primary dealers are banks and broker-dealers authorized by the NY Fed to bid at Treasury auctions and make markets in Treasury securities.
FIA Fixed Income & Bond Markets 5
Which risk describes the possibility that coupon payments cannot be reinvested at a rate equal to the bond's YTM?