Investment Jobs Fixed Income Securities Test 2 — Questions and Answers
Question 1: What is the 'credit spread' on a corporate bond?
- The difference between the bid and ask price
- The yield premium over a comparable Treasury security (Correct answer)
- The bond's coupon rate minus inflation
- The difference between current yield and YTM
Correct answer: The yield premium over a comparable Treasury security
The credit spread is the additional yield a corporate bond offers over a comparable maturity Treasury bond, compensating investors for default and liquidity risk.
Question 2: Which credit rating is the lowest investment-grade rating assigned by Moody's?
- Aaa
- Baa3 (Correct answer)
- B1
- Caa1
Correct answer: Baa3
Baa3 is the lowest investment-grade rating from Moody's; ratings below Baa3 (Ba1 and below) are considered speculative grade or 'junk'.
Question 3: What is a 'zero-coupon bond'?
- A bond that pays interest monthly instead of semi-annually
- A bond issued at a discount that pays no periodic interest but repays full par at maturity (Correct answer)
- A floating rate bond with a minimum coupon floor of zero
- A bond backed by zero-risk government collateral
Correct answer: A bond issued at a discount that pays no periodic interest but repays full par at maturity
A zero-coupon bond pays no periodic interest; it is issued at a deep discount and matures at par value, with the investor's return coming entirely from price appreciation.
Question 4: The yield curve typically slopes upward (normal yield curve) because:
- Short-term bonds are riskier than long-term bonds
- Investors demand higher yields for longer maturities due to greater uncertainty and liquidity risk (Correct answer)
- The Federal Reserve sets long-term rates higher than short-term rates
- Corporate bonds always yield more than Treasuries
Correct answer: Investors demand higher yields for longer maturities due to greater uncertainty and liquidity risk
A normal upward-sloping yield curve reflects the liquidity preference theory: investors require higher compensation for tying up money for longer periods due to greater uncertainty.
Question 5: What are mortgage-backed securities (MBS)?
- Bonds issued by mortgage companies to fund operations
- Securities collateralized by a pool of mortgage loans (Correct answer)
- Loans backed by US government guarantees
- Bonds that convert to real estate ownership
Correct answer: Securities collateralized by a pool of mortgage loans
MBS are financial instruments that represent ownership in a pool of mortgage loans; investors receive principal and interest payments as borrowers make mortgage payments.
Question 6: What is 'negative convexity' and which type of bond commonly exhibits this feature?
- Bonds that lose value when rates fall; zero-coupon bonds
- The price-yield relationship caps upside; callable bonds (Correct answer)
- Bonds with yields below zero; TIPS
- Bonds that mature before their call date; convertible bonds
Correct answer: The price-yield relationship caps upside; callable bonds
Negative convexity means price appreciation is limited when rates fall because the issuer is likely to call the bond; callable bonds and many mortgage-backed securities exhibit this feature.
Investment Jobs Fixed Income Securities Test 2
What is the 'credit spread' on a corporate bond?