QFC QFC Fixed Income & Credit Analysis 1 — Questions and Answers
Question 1: What is the relationship between bond prices and interest rates?
- Positive — prices rise when rates rise
- Inverse — prices fall when rates rise (Correct answer)
- No relationship — they are independent
- Positive only for zero-coupon bonds
Correct answer: Inverse — prices fall when rates rise
Bond prices move inversely to interest rates because the present value of fixed future cash flows falls when discount rates increase.
Question 2: What does 'duration' measure in fixed income analysis?
- Time to maturity of a bond
- Weighted-average time to receive a bond's cash flows, as a measure of interest rate sensitivity (Correct answer)
- The annual coupon payment of a bond
- The credit rating assigned to a bond
Correct answer: Weighted-average time to receive a bond's cash flows, as a measure of interest rate sensitivity
Duration quantifies a bond's price sensitivity to interest rate changes; a higher duration means greater sensitivity.
Question 3: What is the yield spread between a corporate bond and a comparable maturity Treasury bond primarily reflecting?
- Liquidity risk only
- Credit (default) risk and liquidity risk premium demanded by investors (Correct answer)
- Inflation expectations embedded in corporate bonds
- The difference in coupon payment frequencies
Correct answer: Credit (default) risk and liquidity risk premium demanded by investors
The credit spread compensates investors for the additional risk of default and lower liquidity relative to risk-free Treasuries.
Question 4: Which term describes a bond that is issued at a discount and pays no periodic coupon payments?
- Callable bond
- Convertible bond
- Zero-coupon bond (Correct answer)
- Floating rate note
Correct answer: Zero-coupon bond
A zero-coupon bond is sold at a deep discount to par value and returns par at maturity with no intermediate interest payments.
Question 5: In credit analysis, what does the interest coverage ratio measure?
- The ratio of total debt to total assets
- A firm's ability to pay interest expense from operating earnings (Correct answer)
- The proportion of fixed-rate debt in the capital structure
- The default probability implied by CDS spreads
Correct answer: A firm's ability to pay interest expense from operating earnings
The interest coverage ratio (EBIT / Interest Expense) shows how many times operating income covers periodic interest obligations.
Question 6: What is 'convexity' in bond analysis?
- The coupon rate adjustment for inflation
- The second-order measure of bond price sensitivity to yield changes, improving on duration's linear approximation (Correct answer)
- The difference between a bond's yield and the risk-free rate
- The bond's sensitivity to changes in the issuer's credit rating
Correct answer: The second-order measure of bond price sensitivity to yield changes, improving on duration's linear approximation
Convexity accounts for the curvature in the price-yield relationship, providing a more accurate estimate of price changes for large yield moves.
QFC QFC Fixed Income & Credit Analysis 1
What is the relationship between bond prices and interest rates?