CFA Level 1 - Fixed Income Exam
Questions with Correct Answers
Bond Indenture - Answer-Contract that specifies all the rights and obligations of the
issuer and owners of a fixed income security.
Negative Covenants - Answer-Prohibitions on the borrower.
Affirmative Covenants - Answer-Actions that the borrower promises to perform.
Maturity or Term to Maturity - Answer-Length of time until loan contract or agreement
expires. Remaining life of bond.
Par Value - Answer-Amount borrower promises to pay on or before maturity date.
Coupon Rate - Answer-Rate when multiplied by Par Value gives amount of annual
interest payment.
Zero-Coupon Bonds - Answer-Bonds that do not pay interest; Instead sold at a deep
discount from par values. Market convention states semi-annual compounding used
when pricing zeros.
Non-Amortizing Bond (Bullet Bond or Bullet Maturity) - Answer-Characteristic of most T-
Bonds and Corporate bonds. Pay only interest until maturity, at which time full face
value is paid back.
Bullet Bonds - Answer-Pay entire principal in one lump sum at maturity.
Serial Bonds - Answer-Pay off principal thru series of pmts over time.
Amortizing Securities - Answer-Make periodic principal and interest pmts (i.e., MBS &
ABS).
Sinking Fund Provisions - Answer-Provide for the retirement of a bond thru a series of
predefined principal pmts over the life of the issue.
Sinking-Fund Provisions - Answer-Cash Payment - issuer deposits cash with trustee
who retires applicable proportion of bonds at par using lottery selection.
Delivery of Securities - issuer purchases the bonds with equal total par value in the
market and delivers them to trustee who will retire them.
Investor options - Answer-Conversion features, put provisions, and floors.
,Issuer options - Answer-Call provisions, prepayment options, sinking fund provisions,
and caps.
Callable Bond Provisions - Answer-Issuer has right (not obligation) to retire all or part of
bond prior to maturity. There may be several call dates, and customarily when a bond is
called on the first permissible call date, the call price is above par value. The call price
will normally decline over time according to the schedule.
Doubling Option - Answer-Like a Call Option.
Put Provision - Answer-Grants right to sell (put) the bond to the issuer at a specified
price prior to maturity.
When would it be beneficial for a bondholder to exercise a put option? - Answer-If
interest rates have risen and/or the creditworthiness of the issuer has deteriorated so
that the market price of the bond has fallen below par.
Non-Callable Bond - Answer-Absolute protection against call prior to maturity.
Refunding Provisions - Answer-Nonrefundable bonds prohibit premature retirement of
issue using proceeds of a lower cpn bd. Bds that carry these provisions can be freely
callable, but not refundable.
Non-Refundable Bond - Answer-Prohibit call of an issue using proceeds from a lower
coupon bond issue.
Conversion Option - Answer-Grants bondholder right to convert bond into a fixed
number of common shares. Options adds value to bond.
Exchange Option - Answer-Similar to conversion option, but allows conversion into a
security other than common stock.
Floating Rate Securities - Answer-Bonds that pay a variable rate of interest.
Coupon Formula (Floater) - Answer-Formula used to find new rate on a floating-rate
security
[New Coupon Rate = Reference Rate (+) or (-) Quoted Margin].
Deleveraged Floater - Answer-Scaling factor
New Coupon Rate = (b * Reference Rate) (+) or (-) Quoted Margin.
Inverse Floater - Answer-Cpn moves in direction opposite to reference rate
New Coupon Rate = Constant Rate (K) - (L * Reference Rate)
Where K is the constant and L is the multiplier
Coupon Rate Cap - Answer-Maximum rate paid by borrower/issuer.
, Coupon Rate Floor - Answer-Minimum periodic coupon interest payment received by
lender/security owner.
Coupon Rate Collar - Answer-Simultaneous combination of both cap and floor.
Regular Redemption - Answer-When bonds are redeemed under the call provisions
specified in the bond indenture.
Special Redemption - Answer-When bonds are redeemed to comply with a sinking fund
provision or because of a property sale mandated by government authority.
In Margin Buying - Answer-One borrows funds from a broker or a bank to purchase
securities and the securities themselves are the collateral for the margin loan.
Repo - Answer-Arrangement where an institution sells a security with a commitment to
buy it back at a later date at a specified higher price.
Repo Rate - Answer-The annualized percentage difference between lender's purchase
and sell back price.
Why are Repo issuances preferred among lenders? - Answer-They are not regulated by
the Federal Reserve and providebetter collateral positions for the lenders if the sellers
goes bankrupt. Lenders have only an obligation to sell back the repos rather than stake
a claim against sellers' assets.
Inflation-Indexed Bonds - Answer-Coupon formulas based on inflation; Coupon Formula
Ex.: 3% + annual change in CPI.
Type of Risks - Answer-1) Interest rate risk 2) Yield curve risk 3) Call risk
4) Prepayment risk 5) Reinvestment risk 6) Credit risk
7) Liquidity risk 8) Exchange-rate risk 9) Inflation risk
10)Volatility risk 11)
Event risk 12) Sovereign risk
Interest Rate Risk - Answer-The effect of changes in the prevailing market rate of
interest on bond values. Inverse relationship btwn interest rates and bd prices. i.e.,
When rate goes up, bond prices fall.
Interest Rate Risk and Bond Features - Answer-LT to Mat bds exhibit higher int rate risk
(all else the same).
Bds w/ smaller cpns exhibit higher int rate risk (all else the same).
Low cpn then high price vol.
High cpn then low price vol.
LT to Mat then high price vol.
ST to Mat then low price vol.
Questions with Correct Answers
Bond Indenture - Answer-Contract that specifies all the rights and obligations of the
issuer and owners of a fixed income security.
Negative Covenants - Answer-Prohibitions on the borrower.
Affirmative Covenants - Answer-Actions that the borrower promises to perform.
Maturity or Term to Maturity - Answer-Length of time until loan contract or agreement
expires. Remaining life of bond.
Par Value - Answer-Amount borrower promises to pay on or before maturity date.
Coupon Rate - Answer-Rate when multiplied by Par Value gives amount of annual
interest payment.
Zero-Coupon Bonds - Answer-Bonds that do not pay interest; Instead sold at a deep
discount from par values. Market convention states semi-annual compounding used
when pricing zeros.
Non-Amortizing Bond (Bullet Bond or Bullet Maturity) - Answer-Characteristic of most T-
Bonds and Corporate bonds. Pay only interest until maturity, at which time full face
value is paid back.
Bullet Bonds - Answer-Pay entire principal in one lump sum at maturity.
Serial Bonds - Answer-Pay off principal thru series of pmts over time.
Amortizing Securities - Answer-Make periodic principal and interest pmts (i.e., MBS &
ABS).
Sinking Fund Provisions - Answer-Provide for the retirement of a bond thru a series of
predefined principal pmts over the life of the issue.
Sinking-Fund Provisions - Answer-Cash Payment - issuer deposits cash with trustee
who retires applicable proportion of bonds at par using lottery selection.
Delivery of Securities - issuer purchases the bonds with equal total par value in the
market and delivers them to trustee who will retire them.
Investor options - Answer-Conversion features, put provisions, and floors.
,Issuer options - Answer-Call provisions, prepayment options, sinking fund provisions,
and caps.
Callable Bond Provisions - Answer-Issuer has right (not obligation) to retire all or part of
bond prior to maturity. There may be several call dates, and customarily when a bond is
called on the first permissible call date, the call price is above par value. The call price
will normally decline over time according to the schedule.
Doubling Option - Answer-Like a Call Option.
Put Provision - Answer-Grants right to sell (put) the bond to the issuer at a specified
price prior to maturity.
When would it be beneficial for a bondholder to exercise a put option? - Answer-If
interest rates have risen and/or the creditworthiness of the issuer has deteriorated so
that the market price of the bond has fallen below par.
Non-Callable Bond - Answer-Absolute protection against call prior to maturity.
Refunding Provisions - Answer-Nonrefundable bonds prohibit premature retirement of
issue using proceeds of a lower cpn bd. Bds that carry these provisions can be freely
callable, but not refundable.
Non-Refundable Bond - Answer-Prohibit call of an issue using proceeds from a lower
coupon bond issue.
Conversion Option - Answer-Grants bondholder right to convert bond into a fixed
number of common shares. Options adds value to bond.
Exchange Option - Answer-Similar to conversion option, but allows conversion into a
security other than common stock.
Floating Rate Securities - Answer-Bonds that pay a variable rate of interest.
Coupon Formula (Floater) - Answer-Formula used to find new rate on a floating-rate
security
[New Coupon Rate = Reference Rate (+) or (-) Quoted Margin].
Deleveraged Floater - Answer-Scaling factor
New Coupon Rate = (b * Reference Rate) (+) or (-) Quoted Margin.
Inverse Floater - Answer-Cpn moves in direction opposite to reference rate
New Coupon Rate = Constant Rate (K) - (L * Reference Rate)
Where K is the constant and L is the multiplier
Coupon Rate Cap - Answer-Maximum rate paid by borrower/issuer.
, Coupon Rate Floor - Answer-Minimum periodic coupon interest payment received by
lender/security owner.
Coupon Rate Collar - Answer-Simultaneous combination of both cap and floor.
Regular Redemption - Answer-When bonds are redeemed under the call provisions
specified in the bond indenture.
Special Redemption - Answer-When bonds are redeemed to comply with a sinking fund
provision or because of a property sale mandated by government authority.
In Margin Buying - Answer-One borrows funds from a broker or a bank to purchase
securities and the securities themselves are the collateral for the margin loan.
Repo - Answer-Arrangement where an institution sells a security with a commitment to
buy it back at a later date at a specified higher price.
Repo Rate - Answer-The annualized percentage difference between lender's purchase
and sell back price.
Why are Repo issuances preferred among lenders? - Answer-They are not regulated by
the Federal Reserve and providebetter collateral positions for the lenders if the sellers
goes bankrupt. Lenders have only an obligation to sell back the repos rather than stake
a claim against sellers' assets.
Inflation-Indexed Bonds - Answer-Coupon formulas based on inflation; Coupon Formula
Ex.: 3% + annual change in CPI.
Type of Risks - Answer-1) Interest rate risk 2) Yield curve risk 3) Call risk
4) Prepayment risk 5) Reinvestment risk 6) Credit risk
7) Liquidity risk 8) Exchange-rate risk 9) Inflation risk
10)Volatility risk 11)
Event risk 12) Sovereign risk
Interest Rate Risk - Answer-The effect of changes in the prevailing market rate of
interest on bond values. Inverse relationship btwn interest rates and bd prices. i.e.,
When rate goes up, bond prices fall.
Interest Rate Risk and Bond Features - Answer-LT to Mat bds exhibit higher int rate risk
(all else the same).
Bds w/ smaller cpns exhibit higher int rate risk (all else the same).
Low cpn then high price vol.
High cpn then low price vol.
LT to Mat then high price vol.
ST to Mat then low price vol.
