QFC QFC Fixed Income & Credit Analysis 2 — Questions and Answers
Question 1: What is the 'yield to maturity' (YTM) of a bond?
- The bond's annual coupon rate stated on its face
- The discount rate that equates the present value of all cash flows to the bond's current market price (Correct answer)
- The yield earned if the bond is held to first call date
- The difference between the par value and market price
Correct answer: The discount rate that equates the present value of all cash flows to the bond's current market price
YTM is the internal rate of return of a bond assuming all coupons are reinvested at the same rate and held to maturity.
Question 2: What is a 'callable bond' and what risk does it create for investors?
- A bond that converts to equity; creates dilution risk
- A bond the issuer can redeem early; creates reinvestment risk for investors (Correct answer)
- A bond with a floating coupon; creates interest rate risk
- A bond backed by collateral; creates repayment risk
Correct answer: A bond the issuer can redeem early; creates reinvestment risk for investors
A callable bond allows the issuer to redeem it before maturity, typically when rates fall, forcing investors to reinvest at lower yields.
Question 3: In the context of credit ratings, what does an 'investment-grade' rating signify?
- A bond with a maturity of less than one year
- A bond rated BBB-/Baa3 or higher, indicating relatively low default risk (Correct answer)
- A bond issued by a government entity only
- A bond with a coupon rate above the current risk-free rate
Correct answer: A bond rated BBB-/Baa3 or higher, indicating relatively low default risk
Investment-grade bonds (BBB-/Baa3 and above from S&P/Moody's) carry lower default risk and attract institutional investors with credit quality mandates.
Question 4: What does the term structure of interest rates (yield curve) plot?
- Bond credit ratings vs. yield spreads
- Yields of same-issuer bonds of varying maturities (Correct answer)
- Historical yield changes over a specific time period
- The relationship between coupon rate and bond duration
Correct answer: Yields of same-issuer bonds of varying maturities
The yield curve shows the yields on otherwise comparable bonds (same issuer, credit quality) across different maturities at a single point in time.
Question 5: What is a credit default swap (CDS) primarily used for?
- Converting fixed-rate debt to floating-rate debt
- Transferring credit risk of a reference entity from the protection buyer to the protection seller (Correct answer)
- Hedging against currency risk in international bond portfolios
- Locking in a fixed borrowing rate for future debt issuance
Correct answer: Transferring credit risk of a reference entity from the protection buyer to the protection seller
A CDS is a derivative contract where the protection buyer pays periodic premiums and receives a payment if the reference entity defaults.
Question 6: Which fixed income security has its coupon payments tied to a benchmark interest rate such as SOFR?
- Zero-coupon bond
- Convertible bond
- Floating rate note (FRN) (Correct answer)
- Callable bond
Correct answer: Floating rate note (FRN)
A floating rate note resets its coupon periodically based on a reference rate (e.g., SOFR + spread), reducing interest rate risk for the holder.
QFC QFC Fixed Income & Credit Analysis 2
What is the 'yield to maturity' (YTM) of a bond?