Investment Fixed Income and Bonds 1 — Questions and Answers
Question 1: What happens to a bond's price when interest rates rise?
- The price rises proportionally
- The price falls (Correct answer)
- The price remains unchanged
- The price doubles
Correct answer: The price falls
Bond prices and interest rates have an inverse relationship — when rates rise, existing bonds with lower coupon rates become less attractive, so their prices fall.
Question 2: What is the 'par value' of a bond?
- The current market price
- The face value repaid at maturity (Correct answer)
- The total interest paid over the bond's life
- The bond's yield to maturity
Correct answer: The face value repaid at maturity
Par value (also called face value) is the principal amount the issuer promises to repay the bondholder when the bond matures.
Question 3: A bond's coupon rate is 5% and its current market price is below par. What is true about its current yield?
- Current yield equals 5%
- Current yield is less than 5%
- Current yield is greater than 5% (Correct answer)
- Current yield cannot be determined
Correct answer: Current yield is greater than 5%
When a bond trades below par, the fixed coupon payment represents a higher percentage of the lower purchase price, making the current yield greater than the coupon rate.
Question 4: Which type of bond is backed by the full faith and credit of the U.S. federal government?
- Municipal bonds
- Corporate bonds
- Treasury bonds (Correct answer)
- Agency bonds
Correct answer: Treasury bonds
U.S. Treasury bonds are direct obligations of the federal government, backed by its full taxing authority, making them among the safest investments.
Question 5: What is 'yield to maturity' (YTM)?
- The annual coupon payment divided by par value
- The total return earned if a bond is held until it matures (Correct answer)
- The bond's current market price minus par value
- The spread between corporate and Treasury yields
Correct answer: The total return earned if a bond is held until it matures
YTM is the total annualized return an investor would earn if the bond is purchased at the current price and held until maturity, accounting for coupon payments and any gain or loss on principal.
Question 6: What does a bond's 'duration' measure?
- The time until the next coupon payment
- The bond's credit quality
- The sensitivity of a bond's price to changes in interest rates (Correct answer)
- The number of years since the bond was issued
Correct answer: The sensitivity of a bond's price to changes in interest rates
Duration measures how much a bond's price will change in response to a 1% change in interest rates — a higher duration means greater price sensitivity.
Question 7: Which bond rating is considered 'investment grade' according to Standard & Poor's?
- BB and above
- BBB and above (Correct answer)
- B and above
- CCC and above
Correct answer: BBB and above
S&P classifies bonds rated BBB- or higher as investment grade, indicating relatively low default risk and suitable for most institutional investors.
Investment Fixed Income and Bonds 1
What happens to a bond's price when interest rates rise?