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CFA Level 1 - Fixed Income Questions and Answers Fully Solved
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CFA Level 1 - Fixed Income
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CFA Level 1 - Fixed IncomeBond 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 - answerCash 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 - answerConversion features, put provisions, and floors.
,Issuer options - answerCall provisions, prepayment options, sinking fund provisions,
and caps.
Callable Bond Provisions - answerIssuer 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 - answerLike a Call Option.
Put Provision - answerGrants 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? - answerIf
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 - answerAbsolute protection against call prior to maturity.
Refunding Provisions - answerNonrefundable 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 - answerProhibit call of an issue using proceeds from a lower
coupon bond issue.
Conversion Option - answerGrants bondholder right to convert bond into a fixed number
of common shares. Options adds value to bond.
Exchange Option - answerSimilar to conversion option, but allows conversion into a
security other than common stock.
Floating Rate Securities - answerBonds that pay a variable rate of interest.
Coupon Formula (Floater) - answerFormula used to find new rate on a floating-rate
security
[New Coupon Rate = Reference Rate (+) or (-) Quoted Margin].
Deleveraged Floater - answerScaling factor
New Coupon Rate = (b * Reference Rate) (+) or (-) Quoted Margin.
Inverse Floater - answerCpn 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 - answerMaximum rate paid by borrower/issuer.
, Coupon Rate Floor - answerMinimum periodic coupon interest payment received by
lender/security owner.
Coupon Rate Collar - answerSimultaneous combination of both cap and floor.
Regular Redemption - answerWhen bonds are redeemed under the call provisions
specified in the bond indenture.
Special Redemption - answerWhen bonds are redeemed to comply with a sinking fund
provision or because of a property sale mandated by government authority.
In Margin Buying - answerOne borrows funds from a broker or a bank to purchase
securities and the securities themselves are the collateral for the margin loan.
Repo - answerArrangement where an institution sells a security with a commitment to
buy it back at a later date at a specified higher price.
Repo Rate - answerThe annualized percentage difference between lender's purchase
and sell back price.
Why are Repo issuances preferred among lenders? - answerThey 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 - answerCoupon formulas based on inflation; Coupon Formula
Ex.: 3% + annual change in CPI.
Type of Risks - answer1) 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 - answerThe 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 - answerLT 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.
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