Fixed Income 6.1. Basic Features of A Fixed-Income Security 6.1.1. 6.1.1.1. Basic Features of A Fixed-Income Security

6.
Fixed Income
6.1. Basic Features of A Fixed-Income Security
6.1.1.
6.1.1.1. basic features of a fixed-income security
➢ Issuer
◼ Supranational organizations
◼ Sovereign (national) governments
◼ Non-sovereign (local) governments
◼ Quasi-government entities
◼ Companies (i.e., corporate issuers)
➢ Maturity: the date when the issuer is obligated to redeem the bond by paying
the outstanding principal amount.
➢ Tenor: the time remaining until the bond’s maturity date.
➢ Term to maturity
◼ Money market securities: fixed-income securities with maturities at
issuance (original maturity) of one year or less.
◼ Capital market securities: fixed-income securities with original maturities
that are longer than one year.
◼ Perpetual bonds: the consols issued by the sovereign government in the
United Kingdom, which have no stated maturity date.
➢ Par value/face value/ maturity value/principal/redemption value
➢ Coupon rate and frequency
➢ Currency
◼ Dual-currency bond: make coupon payments in one currency and pay the
par value at maturity in another currency.
◼ Currency option bond: a combination of a single-currency bond plus a
foreign currency option.
:
6.1.2.
育
Q-1. A sovereign bond which has a maturity of 15 years can be described as a:

教
程
A. perpetual bond. ( )
金
B. pure discount bond.

C. capital market security.
1-80
此预测为考点预测，考题仅为复习参考
内部使用资料，严禁传播，否则追究法律责任
Q-2. China Construction Development Corporation needs to finance a three-year construction
project in Singapore. The corporation plans to issue a bond with coupon payments to be
paid in Chinese yuan and principal to be repaid in Singapore dollars. This bond is most
likely an example of a: (Mock 2018)
A. dual currency bond.
B. currency option bond.
C. foreign currency bond.
6.2. Sectors of the Bond Market
6.2.1.
6.2.1.1. Sectors of the bond market

➢ The places where fixed-income securities are issued and traded
◼ National bond market
◆ Domestic bond: Bonds issued by entities that are incorporated in that
country.
◆ Foreign bond: Bonds sold in a country and denominated in that
country’s currency by an entity from another country (foreign country)
are referred to as foreign bonds.
◼ Eurobond market
◆ Eurobond: Type of bond issued internationally, outside the jurisdiction
of the country in whose currency the bond is denominated. Bonds
issued and traded on the Eurobond market.
◼ Global bonds: issued simultaneously in the Eurobond market and in at least
one domestic bond market.
6.2.2.
Q-3. A South Korean electronics company issued bonds denominated in US dollars in the
:
United States and registered with the SEC. These bonds are most likely known as a 2019
育
教
Mock C PM
程
A. Foreign bond.
金
B. Eurobond.
C. Global bond.
2-80
6.3. Issuer’s Legal Information
6.3.1.
6.3.1.1. Issuing entities:

➢ Sovereign bonds: are backed by the "full faith and credit” of the national
government.
➢ Corporate bonds: the issuer is usually the corporate legal entity.
➢ Securitized bonds: is legally independent and is considered bankruptcy remote
from the seller of the loans which is called special purpose entities (SPEs) in U.S,
and special purpose vehicles (SPVs) in Europe.
◼ SPV is bankruptcy remote because the assets can provide cash flows to
support the payment of the bond even if the company defaults.
◼ The transfer of assets by the sponsor is considered a legal sale; once the
assets have been securitized, the sponsor no longer has ownership rights.
◼ Any party making claims following the bankruptcy of the sponsor would be
unable to recover the assets or their proceeds.
6.3.1.2. Sources of repayment:
Types of bond Source of repayment
Supranational ◼ Repayment of previous loans

organizations ◼ Paid-in capital from its members
◼ Tax revenues
Sovereign bonds
◼ Print money
◼ General taxing authority of issuer

Non-sovereign debt ◼ Cash flows of the financed project (revenues)
◼ Special taxes or fees
Corporate bonds ◼ Cash flows from operations

:
◼ Cash flows generated by one or more

育
Securitizations
underlying financial assets.
教
程
6.3.2.
金
Q-4. Agency bonds are issued by:
3-80
A. local governments.
B. national governments.
C. quasi-government entities.
Q-5. Which of the following are most likely a kind of supranational bonds? Bonds issued by
the: (Mock 2018)
A. Federal Farm Agency of the United States.
B. Government of Malaysia.
C. European Investment Bank.
Q-6. Proceeds for repaying securitized bonds most likely come from the: Mock 2018
A. claims-paying ability of the operating entity.

B. cash flows of the project the bond is financing.
C. cash flows of the underlying financial assets.
6.4. Collateral and Credit Enhancements
6.4.1.
6.4.1.1. Collateral
➢ Asset or collateral backing: a way to reduce credit risk.
◼ Unsecured bonds: have no collateral; bondholders have only a general
claim on the issuer’s assets and cash flows.
◼ Secured bonds: Are backed by assets or financial guarantees pledged to
ensure debt repayment in the case of default.
◼ Unsecured bonds are paid after secured bonds in the event of default.
◼ In many jurisdictions, debentures are unsecured bonds, with no collateral
backing assigned to the bondholders.
➢ Types of collateral backing:
Types of bond Collateral backing
:
Collateral trust bonds Financial assets

育
Equipment trust Specific types of equipment or physical assets (e.g.

教
certificates railroad cards, oil drilling)

程
Mortgage-backed
金
Mortgage loans
securities (MBS)
Covered bond A segregated pool of assets called a “covered pool”
4-80
6.4.1.2. Credit enhancement: a variety of provisions used to reduce the credit risk of a bond
issue.
➢ Internal credit enhancement:
◼ Overcollateralization: the process of posting more collateral than is needed
to obtain or secure financing.
◼ Reserve accounts or reserve funds: provide credit support by paying for
possible future losses.
◆ Cash reserve fund: deposit of cash that can be used to absorb losses.
◆ Excess spread: involves the allocation into an account of any amounts
left over after paying out the interest to bondholders.
◼ Divide a bond into tranches with different seniority of claims: any losses
of assets supporting a securitized bond are first absorbed by the bonds
with the lowest seniority, then the bonds with the next-lowest priority of
claims——waterfall structure.
➢ External credit enhancement:
◼ Surety bond: issued by insurance companies and is a promise to make up
any shortfall in the cash available to service the debt.
◼ Bank guarantee: similar to surety bond, the major difference is that it
issued by a bank.
◼ Letter of credit: a promise to lend money to the issuing entity if it does not
have enough cash to make the promised payments on the covered debt.
➢ Limitation of external credit enhancement:
◼ while external credit enhancements increase the credit quality of debt
issues and decrease the yields, deterioration of credit quality of the
guarantor will also reduce the credit quality of the covered issue.
◼ Surety bonds, bank guarantees, and letters of credit expose the investor to
third-party (or counterparty) risk, the possibility that a guarantor cannot
meet its obligations.
➢ A cash collateral account: the issuer immediately borrows the credit
enhancement amount and then invests that amount usually in highly rated
:
育
short-term commercial paper. A cash collateral account mitigates investors’

exposure to the third-party risk, which is the possibility that a guarantor cannot
教
meet its obligation.

程
金
6.4.2.
5-80
Q-7. Which of the following is most likely a form of internal credit enhancement?
A. Letter of credit 2019 mock
B. surety bond
C. Overcollateralization
Q-8. Which of the following external credit enhancement has the least amount of third-party
risk?
A. Surety bond
B. Letter of credit
C. Cash collateral account
6.5. Bond Indenture, Affirmative and Negative Covenants
6.5.1.
6.5.1.1. functions of a bond indenture
➢ Describes the form of the bond, the obligations of the issuer, and the rights of
the bondholders.
6.5.1.2. negative covenants affirmative covenants
➢ Negative covenants: frequently costly and do materially constrain the issuer's

potential business decisions.
◼ Restrictions on asset disposals.
◼ Negative pledges
◼ Restrictions on prior claims.
➢ Affirmative covenants: are typically administrative in nature.
◼ Comply with all laws and regulations;
◼ Maintain its current lines of business;
◼ Insure and maintain its assets, and pay taxes as they come due.
:
育
6.5.2.
教
Q-9. Which of the following content is included in negative bond covenants. The issuer is:
程
金
A. required to pay taxes as they come due.
B. prohibited from investing in risky projects.
6-80
C. required to maintain its current lines of business.
Q-10. An analyst reviews a corporate bond indenture that contains these two covenants:
1 The borrower will pay interest semiannually and principal at maturity.
2 The borrower will not incur additional debt if its debt-to-capital ratio is more than
50%.
What types of covenants are these? (Mock 2019)
A. Covenant 1 is affirmative, and Covenant 2 is negative.
B. Both are affirmative covenants.
C. Covenant 1 is negative, and Covenant 2 is affirmative.
6.6. Taxation of Bond Income
6.6.1.
6.6.1.1. Tax consideration

➢ Interest income: taxed as ordinary income at the same rate as wage and salary
income.
◼ Interest income from bonds issued by municipal government: tax-exempt.
➢ Capital gain: gain or loss between purchase price and selling price.
➢ Original issue discount (OID) bonds: a portion of the discount from par at
issuance is treated as taxable interest income each year.
◼ This allows investors to increase their cost basis in the bonds so that at
maturity, they face no capital gain or loss.
◼ Pure-discount bonds: a portion of the discount from par at issuance is
treated as taxable interest income.
◼ Premium bonds: allow investors to deduct a prorated portion of the
amount paid in excess of the bond’s par value from their taxable income
every tax year until maturity.
:
育
6.6.2.
教
Q-11. Ted Nguyen is an investor domiciled in a country with an original issue discount tax
程
provision. He purchases a zero-coupon bond at a deep discount to par value with the
金
intention of holding the bond until maturity. At maturity, he will most likely face:
7-80
A. neither a capital loss nor gain. 2016 mock AM
B. a capital loss.
C. a capital gain.
6.7. Cash Flow Structure
6.7.1.
6.7.1.1. Principal repayment structure

➢ Principal repayment structure
◼ Bullet structure
◆ periodic interest payment(coupon payments) over the life of the bond.
◆ entire principal value at maturity.
◼ Amortizing structure: repay part of principal at each payment date.
◆ fully amortizing structure: equally periodic payment (interest +
principal).
◆ partially amortizing structure: a balloon payment at maturity, which
repays the remaining principal as a lump sum.
◼ Sinking fund provision
◆ requires the issuer to retire a portion of a bond issue at specified
times during the bonds’ life.
◆ The issuer can usually repurchase the bonds at the market price, at
par, or at a specified sinking fund price, whichever is the lowest.
◼ Advantages and disadvantages of sinking fund provision
◆ Advantages: less credit risk due to the periodic redemptions of the
principal.
◆ Disadvantages: more reinvestment risk. When interest rate decreases,
the market price is greater than the redemption price.
✓ First, investors face reinvestment risk, the risk associated with
having to reinvest cash flows at an interest rate that may be lower
than the current yield to maturity.
:
育
✓ Another potential disadvantage for investors occurs if the issuer

教
has the option to repurchase bonds at below market prices.

程
➢ Coupon payment structure

◼
金
Floating-rate notes: coupon rates that are adjusted based on a reference

rate such as LIBOR.
8-80
◆ Coupon rate = reference rate + quoted margin
◆ The coupon rate determined at the coupon reset date is the rate that
the issuer promises to pay at the next coupon date.
◆ Cap and floor
✓ The upper limit is called the cap.
✓ The lower limit is called the floor.
✓ When a floating-rate security has both an upper limit and a lower
limit, the feature is called a collar.
◆ Inverse floaters (also called reverse floaters) have coupon rates that
move in the opposite direction from the change in the reference rate.
◼ Step-up coupon bonds: may be fixed or floating, increasing by specified
margins at specified dates.
◼ Credit-linked coupon bond: has a coupon that changes when the bond’s
credit rating changes.
◼ Pay-in-kind (PIK) bond: allows the issuer to pay interest in the form of
additional amounts of the bond issue rather than as a cash payment.
◼ Deferred coupon bonds (split coupon bond): interest payments are
deferred for a specified number of years.
➢ Index-linked bond: has its coupon payments and/or principal repayment linked
to a specified index.
◼ Equity-linked notes (ELNs): no periodic interest payment and the payment
at maturity are based on an equity index.
◼ Inflation-linked bonds/linkers: are an example of index-linked bonds.
◆ Indexed-annuity bonds: are fully amortized bonds, in contrast to
interest-indexed and capital-indexed bonds that are non-amortizing
coupon bonds
◆ Indexed zero-coupon bonds: The principal amount to be repaid at
maturity increases in line with increases in the price index during the
bond’s life;
◆ Interest-indexed bonds: pay a fixed nominal principal amount at
:
育
maturity, and the inflation adjustment applies to the interest

payments only.
教
◆ Capital-indexed bonds: pay a fixed coupon rate but it is applied to a

程
principal amount that increases in line with increases in the index

金
during the bond’s life.

◼ Principal protected bonds: promise to pay at least the principal at maturity.
9-80
6.7.2.
Q-12. The type of residential mortgage least likely to contain a “balloon” payment is a(n):
A. interest-only mortgage. Mock 2018
B. fully amortizing mortgage.
C. partially amortizing mortgage.
Q-13. Relative to a fully amortized bond, the coupon payments of an otherwise similar partially
amortized bond are:
A. lower or equal.
B. equal.
C. higher or equal.
Q-14. Which of the following terms in a bond issue most likely helps to reduce credit risk?
A. Sinking fund arrangement 2016 mock
B. Floating rate note

C. Term maturity structure
Q-15. An investor is least likely exposed to reinvestment risk from owning a(n): (Mock 2018)
A. amortizing security.
B. zero-coupon bond.
C. callable bond.
Q-16. Centro Corp. recently issued a floating-rate note (FRN) that includes a feature that
prevents its coupon rate from falling below a pre-specified minimum rate. This feature in an
FRN is most likely referred to as a: 2014 Mock AM / 2016,2017 Mock PM
A. Floor.
:
B. Collar.
育
C. Cap.
教
程
Q-17. A 5-year floating rate security was issued on January 1, 2006. The coupon rate formula
金
was 1-year LIBOR + 300 bps with a cap of 10% and a floor of 5% and annual reset. The 1-
10-80
year LIBOR rate on January 1st of each year of the security’s life is provided in the
following table:
Year 1-Year LIBOR
2006 3.5%
2007 4.0%
2008 3.0%
2009 2.0%
2010 1.5%
During 2010, the payments owed by the issuer were based on a coupon rate closest to:
A. 4.5%.
B. 5.0%.
C. 6.5%.
Q-18. A 10-year, capital-indexed bond linked to the Consumer Price Index (CPI) is issued with a
coupon rate of 8% and a par value of 1,000. The bond pays interest semi-annually. During
the first six months after the bond's issuance, the annualized CPI increases by 6%. On the
first coupon payment date, the bond's:
A. coupon rate increases to 11%.
B. coupon payment is equal to 41.2.
C. principal amount increases to 1,100.
Q-19. A company issues a 10-year bond on 1 January 2014. Its contract requires that the
coupon rate increase by specified margins at specified dates as shown in the following
table:
Coupon Payment Date Range Coupon Rate
1 Jan 2014–31 Dec 2015 4.00%
1 Jan 2016–31 Dec 2017 5.00%
:
1 Jan 2018–31 Dec 2019 7.50%

育
1 Jan 2020–31 Dec 2023 9.00%

教
The security is most likely a (n): 2019 AM Mock

程
A. step-up note.
金
B. deferred coupon bond.

C. floating rate bond.
11-80
6.8. Contingency Provisions
6.8.1.
6.8.1.1. Callable bond

➢ Call option: allow the issuer to redeem bonds at a specified call price.
Vcallable bond = Vpure bond- Vcall option
◼ If interest rates fall
◆ Issuer can retire the bond paying high coupon rate, and replace it with
lower coupon bonds.
◆ When the bond is called, the proceeds can only be reinvested at a
lower interest rate.
◼ Three styles of exercise for callable bonds
◆ American style: sometimes referred to as continuously callable, for
which the issuer has the right to call a bond at any time starting on the
first call date;
◆ European style: the issuer has the right to call a bond only once on the
call date;
◆ Bermuda style: the issuer has the right to call bonds on specified
dates following the call protection period.
➢ Make-whole call provision: requires the issuer to make a lump-sum payment to
the bondholders based on the present value of the future coupon payments and
principal repayment not paid because of the bond being redeemed early.
6.8.1.2. Putable bond
➢ Put option: allow the bondholder to sell bonds back to the issuer at a specified
put price
Vputable bonds= Vpure bonds+ Vput option
◼ If interest rates rise
◆ The bondholders can sell the bond back to the issuer and get cash.
◆ When the bond is put, the proceeds can be reinvested at a higher
:
interest rate.
育
6.8.1.3. Convertible bond

教
➢ Conversion option: (benefit bondholders) allow the bondholder to exchange

程
bonds for a specified number of shares of the issuer’s common stock.

金
➢ Conversion price: the price per share at which the convertible bond can be
converted into shares.
12-80
➢ Conversion ratio: the number of common shares that each bond can be
converted into.
➢ Conversion value: parity value, the current share price multiplied by the
conversion ratio.
➢ Conversion parity:
◼ At parity: conversion value = convertible bond’s price
◼ Above parity: conversion value > convertible bond’s price
◼ Below parity: conversion value < convertible bond’s price
6.8.1.4. Warrants and contingent convertible bond
➢ Warrants: (benefit bondholders) entitles the bondholder to buy the underlying
stock of the issuing company at a fixed exercise price until the expiration date.
➢ Contingent convertible bonds (“CoCos”): bonds that convert from debt to
common equity automatically if a specific event occurs.
◼ Banks must maintain specific levels of equity financing. If a bank’s equity
falls below the required level, CoCos are automatically converted to
common stocks.
6.8.2.
Q-20. Relative to an otherwise similar option-free bond, which of the following statement is
correct?
A. callable bond will trade at a higher price.
B. putable bond will trade at a higher price.
C. convertible bond will trade at a lower price.
Q-21. Assume that a convertible bond has a par value of $1,500,000 and is currently priced at
$1,800,000. The underlying share price is $50,000 and the conversion ratio is 40:1. The
conversion condition for this bond is:
A. Above parity.
B. Parity.
:
育
C. Below parity.
教
程
Q-22. Compared with an otherwise identical option-free bond, when interest rates fall, the
金
price of a callable bond will: 2014 Mock PM
A. Rise more.
13-80
B. Rise less.
C. Fall less.
Q-23. If a bank wants the ability to retire debt prior to maturity in order to take advantage of
lower borrowing rates, it most likely issues a: 2015 Mock AM
A. callable bond.
B. putable bond.
C. convertible bond.
Q-24. On 15 December 2013, Alpha Corp. issued a 10-year callable bond paying an annual
coupon of 8%. The bond is callable in whole or in part at any time after 15 December
2018. This type of callable bond is most likely referred to as: (Mock 2018)
A. American style.
B. European style.
C. Bermuda style.
6.9. Primary Market and Secondary Market
6.9.1.
6.9.1.1. Primary market

➢ Public offering: Primary bond markets are markets in which issuers initially sell
bonds to investors to raise capital.
◼ Underwritten offering: with the investment bank or syndicate purchasing
the entire issue and selling the bonds to dealers.
◆ Grey market (“when issued” market): is a forward market for bonds
about to be issued.
◼ Best efforts offering: the investment bank only serves as a broker.
◼ Auction: commonly used by issuing government debts.
◼ Shelf registration: allows certain authorized issuers to offer additional
bonds to the general public without having to prepare a new and separate
:
育
offering circular for each bond issue.

教
➢ Private placement: sale of an entire issue to a qualified investor or a group of

程
investors, which are typically large institutions.

金
6.9.1.2. Secondary markets
14-80
➢ Secondary markets: also called the “aftermarket,” are where existing securities
are traded among investors.
◼ Exchange market: transaction must obey the rules imposed by the
exchange.
◼ OTC Dealer Market (largest): dealers post bid and ask price.
◆ Spread between bid and ask prices are narrower (wider) for liquid (less
liquid) issues
◼ Electronic Trading Network (growth)
➢ Trade settlement:
◼ Corporate bonds: third trading day after trade date (T+3).
◼ Government bonds: the next trading day after the trade date (T+1).
◼ Money market securities: on the day of trade date.
6.9.2.
Q-25. The primary market for bonds is a market:
A. in which bonds are issued for the first time to raise capital.
B. that has a specific location where the trading of bonds takes place.
C. in which existing bonds are traded among individuals and institutions.
Q-26. In major developed bond markets, newly issued sovereign bonds are most often sold to
the public via a(n): (2020 )
A. auction.
B. private placement.
C. best efforts offering.
6.10. Bonds Issued by Government, Nonsovereign Governments, Government Agencies, and

Supranational Entities
:
6.10.1.
育
6.10.1.1. Sovereign government bond, non-sovereign government bond, government agency

教
bonds and supranational bonds

程
➢ Sovereign bonds: are backed by the "full faith and credit” of the national
金
government.
15-80
◼ Highly rated sovereign bonds denominated in local currency are virtually
free of credit risk.
◼ Denominated in the local currency or a foreign currency.
◆ Credit ratings are higher for a sovereign’s local currency bonds
➢ Nonsovereign government bonds: issued by governments but not the national
government.
◼ High credit quality, but lower than sovereign bonds
◼ Municipal bond (in the U.S.)
◆ GO (general obligation)/Tax-Backed Debt : Support by taxing power of
local government
✓ Almost no credit risk
✓ Require voter approval
◆ Revenue Bonds
✓ Supported only through revenues generated by projects.
✓ Involve more risk, provide higher yield.
➢ Agency bonds (quasi-government bonds): issued by entities created by national
government and may be explicitly or implicitly backed by government.
➢ Supranational bonds: issued by supranational agencies (multilateral agencies,
e.g., the IMF, the World Bank) those operate across national.
◼ Highly rated supranational agencies, such as the World Bank, frequently
issue large-size bond issues that are often used as benchmarks issues when
there is no liquid sovereign bond available.
◼ E.g., World bank, the IMF, the Asian Development Bank.
6.10.2.
Q-27. Compared with sovereign bonds, the yield of non-sovereign bonds with similar
characteristics most likely is:
A. Lower.
B. The same.
:
育
C. Higher.
教
程
Q-28. The bond issued by a multilateral agency such as the International Monetary Fund (IMF)
金
can be regarded as a:
A. Sovereign bond.
16-80
B. Supranational bond.
C. Quasi-government bond.
6.11. Bonds Issued by Corporation
6.11.1.
6.11.1.1. Classification of corporate bond

➢ Bank debt
◼ Bilateral loan: is a loan from a single lender to a single borrower.
◼ Syndicated loan: is a loan from a group of lenders, called the “syndicate,” to
a single borrower.
➢ Commercial paper: short term, unsecured, low rate (issued by corporations of
high credit quality) debt.
◼ Exempt from registration, directly placed (sold directly by issuer) or dealer
placed (sold to investor through agents/brokers).
◼ There is very little secondary trading of commercial paper.
◼ In most cases, maturing commercial paper is paid with the proceeds of new
issuances of commercial paper.
◼ Rollover risk: a risk that the issuer will be unable to issue new paper at
maturity.
◼ U.S commercial paper Vs. Eurocommercial paper.
Feature U.S commercial paper Eurocommercial paper
Currency U.S dollar Any currency
Maturity Overnight to 270 days Overnight to 364 days
Discount basis Interest-bearing basis

Interest
(pure discount security) (add-on yield)
Settlement T+0 T+2
Negotiable Can be sold to another Can be sold to another

:
育
➢ Corporate bonds: may have a term maturity structure or a serial maturity

教
structure and may have a sinking fund provision.

程
◼ Serial bond issue: with several maturity dates (known at issuance) and can
金
be redeemed periodically.
◼ Term maturity structure: all the bonds maturing on the same date.
17-80
➢ Medium-term notes: corporate issues that can be structured to meet the
requirements of investors.
6.11.2.
Q-29. A loan made by a group of banks to a private company is most likely:
A. a bilateral loan.
B. a syndicated loan.
C. a private placement.
6.12. Short-Term Funding Available to Banks
6.12.1.
6.12.1.1. Short-term funding available to banks

➢ Customers deposits: including checking accounts, savings accounts, and money
market mutual funds
➢ Certificates of deposit (CDs): interest-bearing CDs that mature on specific dates
and are offered in a range of short-term maturities.
◼ Negotiable certificates of deposit: CDs which may be sold in the wholesale
market
➢ Central bank funds market: banks may buy or sell excess reserves deposited
with their central bank.
➢ Interbank funds: banks make unsecured loans to one another for periods up to
a year.
6.12.1.2. Repurchase agreement(repos)
➢ Repurchase agreement (repos): is the sale of a security with a simultaneous
agreement by the seller to buy the same security back from the purchaser at an
agreed-on price and future date.
➢ Reverse repo agreement: taking the opposite side of a repurchase transaction,
lending funds by buying the collateral security.
:
育
➢ Repo rate: the interest rate on a repurchase agreement.

◼ The repo rate is lower when
教
◆ Repo term is shorter

程
◆ Credit quality of the collateral security is higher

金
◆ Collateral security is delivered to the lender

◆ Interest rate for alternative sources of funds are lower
18-80
➢ Repo margin (haircut): the difference between the market value of the security
used as collateral and the value of the loan.
◼ The repo margin is lower when
◆ Repo term is shorter
◆ Credit quality of the collateral security is higher
◆ Credit quality of the borrower is higher
◆ Collateral security is in high demand or low supply
➢ Advantage of Repurchase (repo) Agreement
◼ Repurchase agreements are not regulated by the Federal Reserve.
◼ Collateral position of the lender in a repo is better in the event of
bankruptcy of the dealer. (liquidity)
6.12.2.
Q-30. The higher the level of repo margin:
A. The higher the quality of the collateral.

B. The higher the credit quality of the counterparty.
C. The longer the length of the repurchase agreement.
Q-31. Which of the following is least likely a short-term funding method available to banks?
A. Central bank funds 2015 Mock AM
B. Syndicated loans
C. Negotiable certificate of deposits
Q-32. A repurchase agreement is most comparable to a(n):
A. Interbank deposit.
B. Collateralized loan.
C. Negotiable certificate of deposit.
:
育
6.13. Structured financial instruments

教
6.13.1.
程
金
6.13.1.1. Structured financial instruments
19-80
➢ Structured financial instruments represent a broad sector of financial
instruments. This sector includes asset-backed securities (ABS) and collateralized
debt obligations (CDOs) and other structured financial instruments.
➢ Four broad categories of instruments
◼ Capital protected instruments
◆ The combination of the zero coupon bond and the call option can be
prepackaged as a structured financial instrument called a guarantee
certificate.
◆ Capital protected instruments offer different levels of capital
protection. A guarantee certificate offers full capital protection. Other
structured financial instruments may offer only partial capital
protection.
◼ Yield Enhancement Instruments
◆ Yield enhancement refers to increasing risk exposure in the hope of
realizing a higher expected return. A credit linked note (CLN) is an
example of a yield enhancement instrument.
◆ It is a type of bond that pays regular coupons but whose redemption
value depends on the occurrence of a well-defined credit event, such
as a rating downgrade or the default of an underlying asset.
◆ A CLN allows the issuer to transfer the effect of a particular credit
event to investors. Thus, the issuer is the protection buyer and the
investor is the protection seller.
◼ Participation Instruments
◆ A participation instrument is one that allows investors to participate
in the return of an underlying asset. Floating-rate bonds can be
viewed as a type of participation instrument.
◆ Most participation instruments are designed to give investors indirect
exposure to a particular index or asset price.
◆ Many structured products sold to individuals are participation
instruments linked to an equity index. In contrast to capital protected
:
育
instruments that offer equity exposure, these participation

instruments usually do not offer capital protection.
教
◼ Leveraged Instruments
程
◆ Leveraged instruments are structured financial instruments created to

金
magnify returns and offer the possibility of high payoffs from small
20-80
investments. An inverse floater is an example of a leveraged
instrument.
◆ Inverse floater coupon rate = C – (L × R);
✓ where C is the maximum coupon rate reached if the reference
rate is equal to zero, L is the coupon leverage, and R is the
reference rate on the reset date.
◆ Inverse floaters with a coupon leverage greater than zero but lower
than one are called deleveraged inverse floaters. Inverse floaters with
a coupon leverage greater than one are called leveraged inverse
floaters.
6.13.2.
Q-33. If an investor holds a credit-linked note and the credit event does not occur, the investor
receives:
A. All promised cash flows as scheduled.

B. All coupon payments as scheduled but not the par value at maturity.
C. All coupon payments as scheduled and the par value minus the nominal value of the reference
asset to which the credit-linked note is linked at maturity.
Q-34. A structured financial instrument whose coupon rate is determined by the formula 5 %-
( 0.5×Libor) is most likely:
A. A leveraged inverse floater.

B. A yield enhancement instrument.
C. A deleveraged inverse floater.
6.14. Bond Valuation with YTM
6.14.1.
:
6.14.1.1. Bond valuation with YTM

育
➢ Critical assumptions:
教
◼ hold the bond until maturity.

程
◼ full, timely coupon, principal payments (no default).

金
◼ coupons are reinvested at original YTM.
21-80
➢ 1 N
coupon coupon coupon + pricipal

price = + + ... +
(1 + YTM) (1 + YTM) 2
(1 + YTM) N
➢ 2 N
coupon coupon coupon + pricipal

price = + + ... +
YTM YTM 2 YTM N
(1 + ) (1 + ) (1 + )
2 2 2
➢ Relationships between price and yield
◼ A bond’s price and YTM are inversely related.
◼ A bond will be priced at a discount (premium) to par value if coupon rate is
less (more) than its YTM.
◼ For a given change in yield, the percentage price increase is greater than
the percentage price decrease.
➢ Value of a zero-coupon bond
maturity value
bond value=
i
(1+ ) number of years´ 2
2
6.14.2.
Q-35. An investor who owns a bond with a 9% coupon rate that pays interest semiannually and
matures in three years is considering its sale. If the required rate of return on the bond
is 11%, the price of the bond per 100 of par value is closest to: (2020 )
A. 95.00.
B. 95.11.
C. 105.15.
Q-36. Given two otherwise identical bonds, when interest rates rise, the price of Bond A
declines more than the price of Bond B. Compared with Bond B, Bond A most likely:
A. has a shorter maturity. (2019 mock A PM)
:
育
B. is callable.
教
C. has a lower coupon.

程
金
22-80
Q-37. A bond with 20 years remaining until maturity is currently trading for 111 per 100 of par
value. The bond offers a 5% coupon rate with interest paid semiannually. The bond’s
annual yield-to-maturity is closest to: (2020 )
A. 2.09%.
B. 4.18%.
C. 4.50%.
Q-38. How much will the value of a three-year $100 par value coupon bond with annual
payments, a coupon rate of 10%, and a discount rate of 6% most likely change if market
interest rates immediately increase by 2% 2019
A. -5.04.
B. -5.54.
C. -5.85.
6.15. Arbitrage-Free Valuation
6.15.1.
6.15.1.1. Arbitrage-free valuation

➢ Spot rates: a sequence of market discount rates that correspond to the cash
flow dates; yields-to-maturity on zero-coupon bonds maturing at the date of
each cash flow.
➢ The no-arbitrage price of a bond is calculated using spot rates:
CPN1 CPN 2 CPN N +Par
no-arbitrage price= + +……+
(1+S1 ) (1+S2 ) 2 (1+SN ) N
6.15.2.
Q-39. A 3-year bond offers a 10% coupon rate with interest paid annually. Assuming the
following sequence of spot rates, the price of the bond is closest to:
:
Time (year) Spot Rates

育
1 8%
教
2 9%
程
3 10%
金
A. 98.56.
B. 100.32.
23-80
C. 102.53.
Q-40. A three-year spot rate of 8% is most likely the:

A. yield to maturity on a coupon-paying bond maturing at the end of Year 3.
B. coupon rate in Year 3 on a coupon-paying bond maturing at the end of Year 6.
C. yield to maturity on a zero-coupon bond maturing at the end of Year 3.
6.16. Relationship Between Price and Time
6.16.1.
6.16.1.1. Relationship between price and time

➢ As maturity approaching, the bond’s price moves to the principal.
premium
par
maturity
discount
6.16.2.
Q-41. Assume a bond with a 10% coupon rate, and paid annually and 3 years to maturity. When
a discount rate of 8%, the value of the bond today is $105.15. One day later, the discount
rate increases to 12%. Assuming the discount rate remains at 12% over the remaining
life of the bond, the price of the bond between today and maturity will:
A. Decreases then remains unchanged 2016 Mock PM
B. Increases then decreases

C. Decreases then increases
Q-42. Consider a $100 par value bond with a 7 percent coupon paid annually and 5 years to
maturity. At a discount rate of 6.0 percent, the value of the bond is $104.21. One year
:
育
later, the appropriate discount rate has risen to 6.5 percent and the bond's value is
$101.71. What part of this change in value is most likely attributable to the passage of
教
程
time?
金
A. $0.37
B. $0.74
24-80
C. $1.76
6.17. Flat Price, Accrued Interest and Full Price
6.17.1.
6.17.1.1. Flat price, accrued interest full price

➢ Accrued interest: the interest received by the seller when a bond trades
between coupon dates.
t
◼ accrued interest=coupon 
T
➢ Clean price (or flat price): the price quoted by bond dealers.
➢ Full price (or dirty price, or invoice price): the amount that the buyer pays to
the seller, which equals the clean price plus any accrued interest.
Full Price = Clean Price +Accrued Interest
6.17.2.
Q-43. The price often quoted by the bond dealers is most likely:
A. flat price.
B. full price.
C. full price plus accrued interest.
Q-44. Bond A, described in the exhibit below, is sold for settlement on 21 June 2015. The full
price that bond A will settle at on 21 June 2015 is closest to:

:
育
• Annual coupon:8%
教
• Coupon payment frequency: semiannual

• Interest payment date:5 April and 5 October
程
• Maturity date: 5 October 2017

金
• Day count convention:30/360

• Annual yield-to-maturity:6%
25-80
A. 104.58.
B. 105.26.
C. 105.89.
6.18. Matrix Pricing
6.18.1.
6.18.1.1. Matrix pricing

➢ Matrix pricing: estimate the market discount rate and price based on the quoted
or flat prices of more frequently traded comparable bonds.
➢ Linear interpolation can be used when the maturities between the valued bond
and the traded bond are different.
6.18.2.
Q-45. A credit analyst is least likely to use matrix pricing to estimate the required yield and
price of a(n): (2208 )
A. newly underwritten bond.

B. inactively traded investment grade bond.
C. actively traded speculative grade bond.
Q-46. An analyst needs to assign a value to an illiquid three-year, 5.0% annual coupon payment
corporate bond. The analyst identifies two corporate bonds that have similar credit
quality: One is a two-year, 6.0% annual coupon payment bond priced at 106.500 per 100
of par value, and the other is a four-year, 5.0% annual coupon payment bond priced at
106.250 per 100 of par value. Using matrix pricing, the estimated price of the illiquid
bond per 100 of par value is closest to:
A. 105.763.
B. 106.375.
:
C. 106.775.
育
教
6.19. Yield Measure

程
6.19.1.
金
6.19.1.1. Yield measures
26-80
➢ Yield measures for fixed-rate bonds
◼ The effective yield of a bond depends on its periodicity, or annual
frequency of coupon payments.
YTM m
Effective yield= (1 + ) −1
m
◆ For annual-pay bond: effective yield = YTM
◆ For bonds with greater periodicity, the effective yields is greater than
YTM
◼ Convert an annual percentage rate for m periods per year (APRm), to an
annual percentage rate for n per year (APRn)
APR𝑚 𝑚 APR𝑛 𝑛
(1+ ) = (1+ )
𝑚 𝑛
➢ Current yield is the ratio of a bond’s annual coupon payment to its price.
◼ sum of coupon payment received over the year

current yield=
flat bond price
➢ For a callable/putable bond, a yield-to-call/yield-to-put may be calculated using
each of the call/put dates and prices. The lowest of these yields and YTM is a
callable bond’s yield-to-worst.
➢ Floating-rate note yields
◼ The margin used to calculate the bond coupon payments is called the
quoted margin.
◼ The margin used to calculate the return of the FRN to its par value is called
the required margin (discount margin).
◆ Selling at par(credit unchanged): required margin = quoted margin
◆ Selling at discount(downgrade of credit): quoted margin < required
margin
◆ Selling at premium(upgrade of credit): quoted margin > required
margin
➢ Yield for money market instruments
◼ Yield quoted on a discount basis: quote on U.S. Treasury bills.
year  FV − PV 
DR = * 
:
days  FV 
育
where DR is the yield quoted on a discount basis.

教
◼ Yield quoted on an add-on basis: LIBOR, bank CD rates.

程
year  FV − PV 
AOR = * 
days  
金
PV
27-80
where AOR is the yield quoted on an add-on basis. Both discount basis and
add-on yields in the money market are quoted as simple annual interest
and can be based on a 360-day or 365-day basis.
◼ Bond equivalent yield for money market security is an add-on yield based
on a 365-day year.
365  FV − PV 
BEY = * 
days  PV 
where AOR is the yield quoted on an add-on basis.
6.19.2.
Q-47. The current yield for a 6% coupon, 8-year bond, with a maturity par value of $100 and
currently priced at $92.50 is closest to: (2019 mock AM )
A. 6.00%.
B. 6.49%.
C. 7.25%.
Q-48. A 180-day commercial paper issue is quoted at a discount rate of 6.50% for a 360-day
year. The bond equivalent yield for this instrument is closest to:
A. 6.50%.
B. 6.72%.
C. 6.81%.
Q-49. An analyst evaluates the following information relating to floating rate notes (FRNs)
issued at par value that have 6-month Libor as a reference rate:
Floating Rate Note Quoted Margin Discount Margin
X 0.60% 0.45%
Y 0.70% 0.70%
:
Z 0.80% 0.85%
育
Based only on the information provided, the FRN that will be priced at a discount on the
教
next reset date is:

程
A. FRN X.
金
B. FRN Y.
C. FRN Z.
28-80
Q-50. A bond with 6 years remaining until maturity is currently trading for 99 per 100 of par
value. The par value of the bond is 1000, The bond offers a 4% coupon rate with interest
paid semiannually. The bond is first callable in 3 years at 101 per 100 of par value, the
bond’s annual yield-to-call is closest to: (2012 )
A. 2.34%.
B. 4.36%.
C. 4.68%.
6.20. Yield Curve
6.20.1.
6.20.1.1. Yield curve
➢ Yield curve: yield maturity
➢ Spot curve(spot rate yield curve): a yield curve for single payments in the future
➢ Yield for coupon bonds: shows the YTM for coupon bonds at various maturities,
which can be calculated by linear interpolation.
➢ Par curve (=par bond yield curve): shows the relationships between yields-to-
maturity and time-to-maturity.
➢ Forward curve: shows the future rates for bonds or money market securities for
the same maturities for annual periods in the future
6.20.2.
Q-51. A yield curve constructed from a sequence of yields-to-maturity on zero-coupon bonds
is the:
A. Par curve.
B. Spot curve.
C. Forward curve.
:
育
教
Q-52. To obtain the spot yield curve, a bond analyst would most likely use the most:
程
A. Recently issued and actively traded government bonds. 2017 Mock AM

金
B. Seasoned and actively traded government bonds.

C. Recently issued and actively traded corporate bonds.
29-80
Q-53. Which of the following statements is most likely correct regarding the spot and forward
curves. The spot curve: 2016 Mock AM
A. Cannot be calculated from the forward curve, but the forward curve can be calculated from
the spot curve.
B. Can be calculated from the forward curve, and the forward curve can be calculated from the
spot curve.
C. Can be calculated from the forward curve, but the forward curve cannot be calculated from
the spot curve.
6.21. Forward Rate
6.21.1.
6.21.1.1. Forward rate

➢ Forward rate: is the interest rate on a bond or money market instrument traded in a
forward market.
➢ Forward rate spot rate
(1+ ST )T = (1+ S 1 )(1+ 1y1y)...(1+ (T - 1) y1y)

6.21.1.2. forward rate bond price
CF1 CF2 CFn

bond value = + + ... +
(1 + S1 ) (1 + S1 )(1 + 1y1y) (1 + S1 )(1 + 1y1y)...(1 + (T − 1)y1y)
6.21.2.
Q-54. Using the following US Treasury forward rates, the value of a 2.5-year $100 par value
Treasury bond with a 6% coupon rate is closest to: (Mock 2018 )
Period Years Forward

Rate
:
1 0.5 1.50%
育
2 1 2.50%
教
3 1.5 3.30%
程
4 2 3.90%
金
5 2.5 4.30%
A. $104.19.
30-80
B. $107.03.
C. $109.87.
Q-55. Assume the following annual forward rates were calculated from the yield curve:
Time Period Forward Rate

0y1y 0.50%
1y1y 0.70%
2y1y 1.00%
3y1y 1.50%
4y1y 2.20%
The four-year spot rate is closest to: (2012 )
A. 0.924%.
B. 1.348%.
C. 1.178%.
6.22. Yield Spread
6.22.1.
6.22.1.1. Yield spread

➢ Yield spread: is the difference in yield between different fixed income
securities.
➢ Benchmark spread: the yield spread over a specific benchmark, usually
measured in basis points.
◼ G-spread: the benchmark is government bond yield.
◼ Interpolated spread/I-spread: the benchmark is swap rate.
◼ Z-spread: the spread that must be added to each rate on the benchmark
yield curve to make the present value of a bond equal to its price.
➢ Option-adjusted spread (OAS): is the Z-spread minus the theoretical value of
the embedded call option.
:
育
◼ Callable bond: ZS>OAS

◼
教
Putable bond: ZS<OAS

程
金
6.22.2.
31-80
Q-56. A 3-year, U.K. Government Benchmark Bond is issued with a coupon rate of 2% and a
price of 100.25. A 3-year, U.K. Government Corporate Bond is issued with a coupon rate
of 5% and a price of 100.65. Both bonds pay interest annually. The current three-year
EUR interest rate swap benchmark is 2.12%. The G-spread in basis points(bps) on the U.K.
corporate bond is closest to:
A. 285 bps.
B. 264 bps.
C. 300 bps.
Q-57. The yield spread of a specific bond relative to the standard swap rate in that currency of
the same tenor is most likely:
A. I-spread.
B. Z-spread.
C. G-spread.
6.23. Securitization Process and Advantages
6.23.1.
6.23.1.1. Securitization process

:
育
6.23.1.2. Benefits of securitization

➢ Lowers or removes the wall between ultimate investors and originating
教
borrowers.
程
➢ Securitization reduces liquidity risk in the financial system.

金
◼ Securitization allows for the creation of tradable securities with better

liquidity than the original loans on the bank’s balance sheet.
32-80
◼ Makes financial markets more efficient and improves liquidity for the
underlying financial claims.
➢ Benefits of SPV in securitization: sell the loan to SPV instead of using it as
collateral
◼ Protect investors from the issuer’s bankruptcy.
◼ Securitization can have lower credit cost than a corporate bond secured by
the same collateral.
➢ Funding cost of issuing an asset-backed bond is less than that of issuing a
corporate bond.
6.23.2.
Q-58. A BBB rated corporation wishes to issue debt to finance its operations at the lowest cost
possible. If it decides to sell a pool of receivables into a special purpose vehicle (SPV), its
primary motivation is most likely to: (2020 mock C AM)
A. receive a guaranty from the SPV to improve the corporation’s credit rating.
B. allow the corporation to retain a first lien on the assets of the SPV.
C. segregate the assets into a bankruptcy-remote entity for bondholders.
6.24. Characteristics of Mortgage Loan
6.24.1.
6.24.1.1. Mortgage loan

➢ Foreclosure: allows the lender to take possession of the mortgaged property
and then sell it in order to recover funds toward satisfying the debt obligation
◼ Recourse loan: the lender has a claim against the borrower for the shortfall
between the amount of the mortgage balance outstanding and the
proceeds received from the sale of the property.
◼ Nonrecourse loan: the lender does not have such a claim, so the lender can
look only to the property to recover the outstanding mortgage balance.
◼ Strategic default: A strategic default is less likely in a recourse provision
:
育
because the lender can seek restitution from the borrower’s other assets
教
and/or income in an attempt to recover the shortfall.

程
6.24.1.2. Interest rate of mortgage loan

➢
金
Interest rate determination: mortgage rate or contract rate
33-80
◼ Fixed rate: the mortgage rate remains the same during the life of the
mortgages.
◼ Adjustable or variable rate: The mortgage rate is reset periodically (daily,
weekly, monthly, or annually).
◆ Indexed-referenced ARM
◆ reviewable ARM
◼ Initial period fixed rate
◆ Rollover or renegotiable mortgage: the adjustment calls for a fixed
rate.
◆ Hybrid mortgage: the mortgage starts out with a fixed rate and then
becomes an adjustable rate after a specified initial term.
◆ Convertible mortgage: the mortgage rate is initially either a fixed rate
or adjustable rate. At some point, the borrower has the option to
convert the mortgage into a fixed rate or an adjustable rate for the
remainder of the mortgage’s life.
6.24.1.3. Amortization schedule of mortgage loan
➢ Periodic mortgage payments assuming no prepayments are made: interest
payments and scheduled principal repayments
➢ The amortization of a loan: gradual reduction of the amount borrowed over
time.
◼ Fully amortizing loan: the sum of all the scheduled principal repayments
during the mortgage’s life is such that when the last mortgage payment is
made, the loan is fully repaid.
◼ Partially amortizing loan: the sum of all the scheduled principal repayments
is less than the amount borrowed (balloon payment).
◼ Interest-only mortgage (IO): if no scheduled principal repayment is
specified for a certain number of years.
6.24.1.4. Types of Agency RMBS
➢ Government National Mortgage Association (Ginnie Mae).
➢ Federal Home Loan Mortgage Corporation (Freddie Mac).
:
育
➢ Federal National Mortgage Association (Fannie Mae).

6.24.1.5. Conforming and non-conforming
教
➢ If a loan satisfies the underwriting standards for inclusions as collateral for an

程
agency MBS, it is called a conforming mortgage.

金
➢ Nonconforming mortgage pass-through securities are issued by thrifts,

commercial banks, and private conduits.
34-80
6.24.2.
Q-59. Relative to a non-recourse mortgage loan, in a recourse mortgage loan the:

A. lender can change the interest rate charged. (2020 mock C PM)
B. borrower does not have a strategic default option.
C. borrower is not liable for any shortfall between the property sale proceeds and the loan
amount.
Q-60. In a mortgage pass-through security the pass-through rate:

A. Is adjusted as market rates rise or fall.
B. Is equal to the mortgage rate on the underlying pool of mortgages.
C. Adjusts the rate on the underlying pool of mortgages by a servicing fee.
6.25. Prepayment Risk
6.25.1.
6.25.1.1. Prepayment risk

➢ Contraction risk
◼ The proceeds received must now be invested at lower interest rates.
◼ Price appreciation is not as great as that of an otherwise identical bond
that does not have a prepayment or call option.
➢ Extension risk
◼ The value of the security has fallen because interest rates are higher.
◼ Income they receive can potentially reinvest is typically limited to the
interest payment and scheduled principal repayments.
6.25.1.2. Prepayment risk measurement
➢ Two industry conventions: CPR and PSA.
◼ Single monthly mortality(SMM): monthly measure
Prepayment for month
SMM =
(Beginning mortgage balance for month − scheduled principal repayment for month)
:
育
◼ Public Securities Association (PSA)

◆ The PSA prepayment benchmark assumption: prepayment rates are
教
low for newly originated mortgages and then speed up as the

程
mortgages become seasoned.

金
✓ Benchmark: 100PSA.
35-80
✓ PSA assumption>100PSA: prepayment faster than the
benchmark.
✓ PSA assumption<100PSA: prepayment slower than the
benchmark.
◆ The PSA standard benchmark:100%PSA
✓ CPR=0.2% for the first month after origination, increasing by 0.2%
per month up to 30 months. For example, the CPR in month 14 is
2.8%;
✓ CPR=6% for months 30 to 360;
✓ After 30 months, no prepayment rate is added.
6.25.2.
Q-61. As interest rates rise and fall, investors in mortgaged-backed securities most likely face
what type of risk? (2020 Mock A PM)
A. Extension risk and contraction risk
B. Single-month mortality (SMM) risk and contraction risk
C. Conditional prepayment rate (CPR) risk and extension risk
Q-62. Assume that an investor has invested in a mortgage pool with a $100,000 principal
balance outstanding. The scheduled monthly principal payment is $28.61.
The mortgage pool has a conditional prepayment rate (CPR) of 6% and pool is seasoned.
The single monthly mortality rate is closest to:
A. 0.005098.
B. 0.005113.
C. 0.005143.
6.26. Collateralized Mortgage Obligations(CMO)
6.26.1.
:
育
6.26.1.1. Different types of CMOs

➢ Sequential pay tranches
教
◼ Each class of bonds is retired sequentially in sequential pay CMO.

程
◼ The CMO structure with sequential-pay tranches allows investors

金
concerned about extension risk to invest in shorter-term tranches and

those concerned about contraction risk to invest in the longer-term tranche
36-80
Tranche Contraction risk Extension risk
A (sequential pay) HIGH LOW
B (sequential pay)
C (sequential pay)
D (sequential pay) LOW HIGH
6.26.1.2. PAC and support structure

➢ PAC and support tranches
◼ A PAC is a tranche that is amortized based on a sinking fund schedule that
is established within a specified band over the collateral’s life
➢ PAC and support tranches in prepayment risk
◼ The greater certainty of the cash flow for the PAC bonds comes at the
expense of the non-PAC tranches (support tranches). It is these tranches
that absorb the prepayment risk.
◼ PAC tranches have protection against both extension risk and contraction
risk, providing two-sided prepayment protection.
◼ Support tranches expose investors to the greatest level of prepayment risk
while provide prepayment protection for the PAC tranches.
◼ The extent of prepayment risk protection provided by a support tranche
increases as its par value increases relative to its associated PAC tranche.
◼ If the support tranches are paid off quickly because of faster-than-expected
prepayments, they no longer provide any protection for the PAC tranches
◼ Reduce the extension risk: Support tranches do not receive any principal
until the PAC tranches receive their scheduled principal repayment
◼ Reduce the contraction risk: Support tranches absorb any principal
repayments in excess of the scheduled principal repayments that are made
Tranche Contraction risk Extension risk
A (PAC I) LOW LOW

:
育
B (PAC I)
教
B (PAC II)
程
B (PAC II)
金
Support tranche HIGH HIGH
37-80
➢ Initial PAC collar
◼ The lower and upper PSA prepayment assumptions are called the “initial
PAC collar” or the “initial PAC band.” The PAC collar for a CMO is typically
dictated by market conditions.
◼ For example
The average life for a hypothetical structure that includes a PAC I tranche
and a support tranche at various PSA speeds, assuming the PSA speed stays
at that level for the entire life of the PAC tranche.
PSA PAC Tranche(P) Support Tranche(S)

50 10.2 24.9
75 8.6 22.7
100 6.5 20.0
165 6.5 Initial Collar 10.7
250 6.5 3.3
300 5.5 1.9
350 4.0 1.4
◆ When PSA speed in a certain range(100<PSA Speed<250, as showed
above), the average life of PAC I tranche are stable (6.5 years, as
showed above);
◆ When PSA speed exceed upper limit of initial collar(PSA Speed>250, as
showed above), the average life of PAC I tranche would shorten (5.5 or
4.0 years, as showed above);
◆ When PSA speed exceed lower limit of initial collar(PSA Speed<100, as
showed above), the average life of PAC I tranche would extend (22.7 or
24.9 years, as showed above).
6.26.2.
Q-63. Consider the planned amortization class (PAC) tranches in a collateralized mortgage
:
obligation (CMO) are provided protection against both extension and contraction risk. If
育
the prepayment speed is slower than the lower collar on the PAC. Which of the following
教
statements is most accurate? The:

程
A. Average life of the PAC tranche will extend.

金
B. PAC tranche has no risk of prepayments.

C. Average life of the support tranche will contract.
38-80
Q-64. In a securitization structure, credit tranching allows investors to choose between:
A. extension risk and contraction risk. 2017 Mock AM
B. subordinated bonds and senior bonds.

C. partially amortizing loans and fully amortizing loans.
6.27. Non-Agency RMBS
6.27.1.
6.27.1.1. Difference between agency RMBS vs non-agency RMBS

➢ RMBS issued by Government Sponsored Enterprises (GSEs): credit risk is
reduced by the guarantee of the Government Sponsored Enterprises (GSE) itself;
RMBS issued by non-agency: use credit enhancements to reduce credit risk.
➢ Government Sponsored Enterprise (GSE) RMBS must satisfy specific
underwriting standards established by various government agencies; No
restrictions apply to the types of mortgage loans that can be used to back a non-
agency RMBS.
6.27.1.2. Internal and External Credit Enhancement
➢ Internal credit enhancements
◼ Senior/subordinated structure: the subordinated bond classes(junior bond
classes or non-senior bond classes) provide credit support for the senior
bond classes
◆ The subordination levels are set at the time of issuance and change
over time as voluntary prepayments and defaults occur
◆ A deal designed to keep the amount of credit enhancement from
deteriorating over time
✓ Shifting interest mechanism: locks out subordinated bond classes
from receiving payments for a period of time if the credit
enhancement for senior tranches deteriorates because of poor
performance of the collateral
:
育
◼ Reserve funds provide credit support by paying for possible future losses
教
◆ Cash reserve fund: deposit of cash provided to the SPV from the
程
proceeds of the sale of the loan pool by the entity seeking to raise
金
funds
◆ Excess spread amount
39-80
✓ allocation into an account of any amount resulting from monthly
funds remaining after paying out the interest to the bond classes
➢ External credit enhancements: Credit support in the case of defaults resulting in
losses in the pool of loans is provided in the form of a financial guarantee by a
third party to the transaction.
◼ The most common third party financial guarantors are monoline insurance
companies, referred to as a monoline insurer
◆ Private insurance company whose business is restricted to providing
guarantees for financial products, such as municipal securities and
ABS.
6.27.2.
Q-65. An asset-backed securitization with a waterfall structure is most likely using which type
of credit enhancement? (2020 mock C AM)
A. Subordination
B. Time tranching
C. Special-purpose entity (SPE)
6.28. CMBS
6.28.1.
6.28.1.1. CMBS characteristics

➢ CMBS are no recourse loans;
◼ Therefore, analysis of CMBS securities focuses on the property and not the
borrower
net operating income
Debt-to-service coverage ratio=
debt service
current mortgage amount
Loan-to-value ratio=
current appraised value
6.28.1.2. CMBS basic structure
:
➢ Call protection (loan level)

育
◆ Prepayment lockout. is a contractual agreement that prohibits any

教
prepayments during a specified period of time.

程
◆ Defeasance. The borrower provides sufficient funds for the servicer to

金
invest in a portfolio of government securities that replicates the cash

flows that would exist in the absence of prepayments.
40-80
✓ The cost of assembling such a portfolio is the cost of defeasing
the loan that must be repaid by the issuer.
◆ Prepayment penalty points. Predetermined penalties that a borrower
who want to refinance must pay.
◆ Yield maintenance charges (make-whole charge). is a penalty paid by
the borrower that makes refinancing solely to get a lower mortgage
rate uneconomical for the borrower.
✓ Designed to make the lender indifferent as to the timing of
prepayments.
➢ Balloon maturity provisions
◼ Balloon loans require substantial principal payment at the end of the term
of the loan
◼ If the borrower fails to make the balloon payment, the borrower is in
default (extension risk)
◼ The lender may modify the original loan terms and charge a higher interest
rate, called “workout period”.
6.28.2.
Q-66. Credit risk is a factor for commercial mortgage-backed securities because they are
backed by mortgage loans that:
A. are non-recourse.
B. have limited call protection.
C. have no prepayment penalty points.
Q-67. In the context of commercial mortgage-backed securities (CMBS) which of the following
mechanisms is most likely a structural call protection? (Mock 2018)
A. Prepayment lockouts
B. Yield maintenance charges
C. Sequential-pay tranches
:
育
教
6.29. Non-Mortgage Asset-Backed Securities

程
6.29.1.
金
6.29.1.1. Auto loan receivable-backed securities

➢ Cash flows
41-80
◼ Regularly scheduled monthly loan payments (interest payments and
scheduled principal repayments).
◼ Any prepayments.
◆ Sales, trade-ins requiring full payoff of the loan, repossession and
subsequent resale of vehicles.
◆ insurance proceeds received upon loss or destruction of vehicles.
◆ payoffs of the loan with cash to save on the interest cost, refinancing
of the loans at a lower interest rate.
➢ Credit enhancement
◼ Senior/subordinated.
◼ Reserve account, overcollateralization, and excess interest on the
receivables.
6.29.1.2. Credit card receivable-backed securities
➢ Cash flow:
◼ Finance charges collected, Fees, Principal repayments.
➢ Lockout periods: cash flow paid out based on finance charges collected and fee.
◼ After lockout periods: principal no longer reinvested but paid to investors.
6.29.2.
Q-68. Which of the following is least likely a feature of an auto loan ABS? (2020 mock C PM)
A. Non-amortizing collateral
B. Overcollateralization
C. Senior/subordinated tranche structure
Q-69. Which of the following is least likely a feature of a credit card receivable ABS?
A. An early amortization provision
B. Amortizing collateral
C. A lockout period
:
育
6.30. CDO
教
6.30.1.
程
金
6.30.1.1. CDO
➢ Collateralized debt obligation (CDO)
42-80
Corporate bonds
Collateralized bond obligation (CBO)
Emerging market bonds
Leveraged Bank loans Collateralized loan obligation (C LO)
ABS, RMBS, CMBS and other CDOs Structured finance CDOs
A portfolio of credit default swaps Synthetic CDOs
➢ Structure of CDO transaction
Senior tranche Highest credit ratings
Credit ratings between senior and

Mezzanine tranche
subordinated bond classes
Subordinate/residual or equity tranche Receive the residual cash flow
➢ Interest rate swap:
pool ⎯⎯⎯
float
fixed
→ CDO ⎯⎯ ⎯
float
→ investor
Fixed Float
swap
6.30.2.
Q-70. From the perspective of a CDO manager, an arbitrage collateralized debt obligation most
likely differs from a traditional asset-backed security because it involves the: (Mock 2018)
A. pooling of debt obligations.
B. active management of the collateral.
C. creation of a special purpose entity.
6.31. Covered Bonds
6.31.1.
:
6.31.1.1. Covered Bonds

育
➢ Covered bonds are senior debt obligations issued by a financial institution and
教
backed by a segregated pool of assets that typically consist of commercial or

程
residential mortgages or public sector assets.

金
➢ Advantages
◼ Dual recourse nature;
43-80
◼ Strict eligibility criteria;
◼ Dynamic cover pool;
◼ Redemption regimes in the event of sponsor default.
➢ As a result, covered bonds usually carry lower credit risks and offer lower yields
than otherwise similar ABS.
6.31.2.
Q-71. Which statement about covered bonds is least accurate? ( )
A. Covered bonds provide investors with dual recourse, to the cover pool and also to the issuer.
B. Covered bonds usually carry higher credit risks and offer higher yields than otherwise similar
ABS.
C. Covered bonds have a dynamic cover pool, meaning sponsors must replace any prepaid or
non-performing assets.
6.32. Sources of Return from Investing in A Fixed-Rate Bond
6.32.1.
6.32.1.1. Three sources of return:

➢ Coupon and principal payments
➢ Reinvestment of coupon payments
➢ Capital gain or loss if bond is sold before maturity
➢ Total return: future value of reinvested coupon interest payments and the sale
price (par value if the bond is held to maturity)
➢ A point on the trajectory represents the carrying value of the bond at that time.
The carrying value is the purchase price plus the amortized amount of the
discount if the bond is purchased at a price below par value, while it is the
purchase price minus the amortized amount of the premium if the bond is
purchased at a price above par value.
6.32.1.2. Annualized holding period return: calculated as the compound annual return
:
育
earned from the holding period

total return 1n
教
auunalized holding period return = ( ) −1

bond price
程
6.32.1.3. Relationship with investment horizon and YTM

金
➢ An investor who holds a fixed-rate bond to maturity will earn an annualized rate
of return equal to the YTM of the bond when purchased.
44-80
➢ An investor who sells a bond prior to maturity will earn a rate of return equal to
the YTM at purchase if the YTM at sale has not changed since purchase.
➢ If the market YTM for the bond, our assumed reinvestment rate, increases
(decreases) after the bond is purchased but before the first coupon date, a buy-
and-hold investor's realized return will be higher (lower) than the YTM of the
bond when purchased.
➢ If the market YTM for the bond, our assumed reinvestment rate, increases after
the bond is purchased but before the first coupon date, a bond investor will earn
a rate of return that is lower (higher) than the YTM at bond purchase if the bond
is held for a short period.
➢ If the market YTM for the bond, our assumed reinvestment rate, decreases after
the bond is purchased but before the first coupon date, a bond investor will earn
a rate of return that is lower (higher) than the YTM at bond purchase if the bond
is held for a long period.
6.32.1.4. Relationship with investment horizon and price risk, reinvestment risk
➢ Short investment horizon:
◼ market price risk > reinvestment risk
◼ annualized holding period return is negatively related with YTM
➢ Long investment horizon:
◼ market price risk < reinvestment risk
◼ annualized holding period return is positively related with YTM
6.32.2.
Q-72. An investor purchases a nine-year, 8% annual coupon payment bond at a price equal to
par value. After the bond is purchased and before the first coupon is received, interest
rates increase to 10%. The investor sells the bond after five years. Assume that interest
rates remain unchanged at 10% over the five-year holding period. Assuming that all
coupons are reinvested over the holding period, the investor's five-year horizon yield is
closest to:
:
育
A. 5.66%.
教
B. 6.11%.
程
C. 7.34%.
金
45-80
Q-73. Which of the following conditions is not required for the realized horizon yield to equal
the original yield to maturity on an option-free, fixed-coupon bond? (Mock 2018)
A. The coupon payments are reinvested at the same interest rate as the original yield to maturity.
B. The bond is sold at a price on the constant-yield price trajectory.
C. The bond is held to maturity.
6.33. Macaulay, Modified and Effective Durations, Money Duration and PVBP
6.33.1.
6.33.1.1. macaulay duration, modified duration effective duration
➢ Interest rate risk: the price sensitivity to interest rate changes. More sensitive,
more possible price volatility.
➢ Duration: measures the sensitivity of the bond’s full price to changes in interest
rates.
➢ Macaulay duration: The average time period of cash flow returning weighted by
discounted cash flow.
n
 t  PVCF t n
◼ Macaulay duration= t =1
=  [t  ( PVCF / P )]
 PVCF (= P )
t 0
t 0 t =1
➢ Modified duration: provides a linear estimate of the percentage price change

for a bond given a 1% change in its yield-to-maturity.
◼ Macaulay duration
Modified duration=
1+periodic market yield
𝑉− −𝑉+
➢ Approximate modified duration =
2×𝑉0 ×Δ𝑌𝑇𝑀
➢ Effective duration: a linear estimate the percentage change in price given a 1%

change in a benchmark yield curve.
𝑉 −𝑉
◼ Effective duration = 2×𝑉 −×ΔCurve
+
0
6.33.1.2. Money duration and PVBP

:
➢ Money duration: a measure of the percentage price change of a bond given a

育
change in its yield-to-maturity and it is calculated as the annual modified

教
duration times the full price of the bond

程
Money duration=annual modified duration × full price of bond

金
Money duration per 100 units of par value=annual modified duration × full price
of bond per 100 of par value
46-80
➢ PVBP (=price value of a basis point): the money change in full price of a bond
when its YTM changes by one basis point (0.01%)
( PV− ) − ( PV+ )
PVBP =
2
PVBP=money duration×0.01
6.33.1.3. Duration
➢ Lower coupon means higher duration.

➢ Longer maturity means higher duration.
➢ Lower market yield means higher duration
➢ A put or call provision means lower duration
6.33.1.4. Duration of perpetual bond and zero-coupon bond
➢ A perpetuity or perpetual bond (consols): a bond that does not mature. There
is no principal to redeem. The investor receives a fixed coupon payment forever,
unless the bond is callable. Non-callable perpetuities are rare.
1 + YTM
◼ Macaulay duration of perpetuity or perpetual bond =
YTM
➢ Duration of zero-coupon bond is equal to time-to-maturity.
6.33.1.5. Portfolio duration
➢ Calculate the weighted average of durations of bonds in the portfolio.
Portfolio duration = w1D1+ w2D2 + ……+wnDn
➢ Limitations: the measure of portfolio duration implicitly assumes a parallel shift
in the yield curve.
◼ A parallel yield curve shift implies that all rates change by the same amount
in the same direction.
◼ In reality, interest rate changes frequently result in a steeper or flatter yield
curve. (non-parallel shifts → key rate duration)
6.33.1.6. Empirical Duration
➢ A measure of a bond’s sensitivity to a change in the benchmark yield curve at a
specific maturity segment.
➢ In contrast to effective duration, key rate durations help identify “shaping risk”
:
育
for a bond-that is, a bond’s sensitivity to changes in the shape of the benchmark
yield curve. (such as: yield curve becoming steeper or flatter).
教
◼ For a government bond (with little or no credit risk): we would expect

程
analytical and empirical duration to be similar because benchmark yield

金
changes largely drive bond prices.
47-80
◼ For high-yield bond: Since credit spreads and benchmark yields are
negatively correlated under a market stress scenario, wider credit spreads
will partially or fully offset the decline in government benchmark yields,
resulting in lower empirical duration estimates than analytical duration
estimates.
6.33.2.
Q-74. An investor buys a 6% annual payment bond with three years to maturity. The bond has
a yield-to-maturity of 8% and is currently priced at 948.45806 per 1000 of par. The bond's
Macaulay duration is closest to:
A. 2.66.
B. 2.83.
C. 3.00.
Q-75. In a rising interest rate environment, the effective duration of a putable bond relative to
an otherwise identical non-putable bond, will most likely be: 2017 Mock PM
A. higher.
B. lower.
C. the same.
Q-76. A fixed-income security's current price is $103.25. The manager estimates that the price
will rise to $106.75 if interest rates decrease 0.35% or fall to $102.10 if interest rates
increase 0.35%. The security's effective duration is closest to: 2014 Mock PM
A. 6.22.
B. 6.43.
C. 6.51.
:
Q-77. An eight-year, 3.5% annual coupon bond is priced at 92.1492, with a yield to maturity of
育
4.7% and a Macaulay duration of 7.0705. If rates decrease by 75 bps, the percentage
教
price change of the bond is closest to: (2020 mock B PM)

程
A. - 5.30%.
金
B. 5.07%.
C. 5.30%.
48-80
Q-78. Which of the following statements is least accurate regarding the factors that affect the
interest rate risk characteristics of an option-free bond? 2017 Mock PM
A. The longer the bond's maturity, the greater the bond's price sensitivity to changes in interest
rates.
B. The lower the coupon rate, the greater the bond's price sensitivity to changes in interest rates.
C. The higher the yield, the greater the bond's price sensitivity to changes in interest rates.
Q-79. Assuming no change in the credit risk of a bond, the presence of an embedded put option:
A. reduces the effective duration of the bond.
B. increases the effective duration of the bond.

C. does not change the effective duration of the bond.
Q-80. Using the information below, and prices are per 100 of par value. The bond portfolio’s
money duration is closest to: (2208 )
Market Modified
bond Full price
value duration
A 95.00 180,000 7.5
B 85.00 100,000 5.5
C 90.00 120,000 10
A. 686.40
B. 707.50
C. 735.60
Q-81. One limitation as to why using the average duration of the bonds in a portfolio does not
properly reflect that portfolio’s yield curve risk is that the approach assumes:
A. a parallel shift in the yield curve. (2020 mock C PM)
B. all the bonds have the same discount rate.
:
育
C. a non-parallel shift in the yield curve.

教
Q-82. The option-free bonds issued by ALS Corp. are currently priced at 105.85. Based on a
程
portfolio manager's valuation model, a 1bp increase in interest rates will result in the
金
bond price falling to 105.75 whereas a 1bp decrease in interest rates will result in the
49-80
bond price rising to 105.90. The price value of a basis point (PVBP) for the bonds is closest
to: (Mock 2018 )
A. 0.025.
B. 0.050.
C. 0.075.
Q-83. Consider two bonds that are identical except for their coupon rates. The bond that will
have the highest interest rate risk most likely has the: (2020 mock B AM)
A. lowest coupon rate.
B. coupon rate closest to its market yield.
C. highest coupon rate.
Q-84. Empirical duration is likely the best measure of the impact of yield changes on portfolio
value, especially under stressed market conditions, for a portfolio consisting of:
A. 100% sovereign bonds of several AAA rated euro area issuers.
B. 100% covered bonds of several AAA rated euro area corporate issuers.
C. 25% AAA rated sovereign bonds, 25% AAA rated corporate bonds, and 50% high-yield (i.e.,
speculative-grade) corporate bonds, all from various euro area sovereign and corporate
issuers. ( )
6.34. Duration Gap
6.34.1.
6.34.1.1. Duration gap

➢ Duration gap = Macaulay duration – investment horizon
◼ If investment horizon > Macaulay duration, then reinvestment risk
dominates price risk, investor’s risk is to lower interest rates.
◼ If investment horizon = Macaulay duration, then reinvestment risk offsets
price risk.
:
育
◼ If investment horizon < Macaulay duration, then price risk dominates

reinvestment risk, investor’s risk is to higher interest rates.
教
程
金
6.34.2.
50-80
Q-85. When a bond investor’s coupon reinvestment risk dominates market price risk, the
investor’s investment horizon must be: (2020 mock C AM)
A. less than the Macaulay duration of the bond.
B. equal to the Macaulay duration of the bond.
C. greater than the Macaulay duration of the bond.
Q-86. A long-term bond investor with an investment horizon of 8 years invests in option-free,
fixed-rate bonds with a Macaulay duration of 10.5. The investor most likely currently has
a: 2016 Mock PM
A. positive duration gap and is currently exposed to the risk of lower interest rates.
B. positive duration gap and is currently exposed to the risk of higher interest rates.
C. negative duration gap and is currently exposed to the risk of higher interest rates.
:
育
教
程
金
51-80
6.35. Convexity
6.35.1.
6.35.1.1. Approximate convexity and effective convexity

➢ Approximate convexity: a measure of the curvature of the price-yield
curve.
V− + V+ − 2V0
approximate convexity =
(YTM) 2 V0
➢ Effective convexity: appropriate for bonds with embedded options.
V− + V+ − 2V0
Effective convexity =
(curve) 2 V0
6.35.1.2. Measurement of Interest Rate Risk
1
% full price = -annual modified duration(YTM) + annual convexity(YTM)
2
2
6.35.1.3. callable and putable convexity
➢ For callable bond, the effective convexity may be negative if yield is lower.
➢ For putable bond, the effective convexity may be higher than that of
comparable pure bond.
:
育
教
程
金
6.35.2.
52-80
Q-87. The option-free bonds of Argus Corporation have a duration of eight years. When
interest rates rise by 100 bps, the bond’s price declines by 7.9%. When interest rates fall
by 100 bps, however, the price rises by 8.2%. The asymmetrical price change is most
likely caused by the: 2019 mock C AM
A. coupon effect.
B. maturity effect.
C. convexity effect.
Q-88. A bond has a modified duration of 10 and convexity of 75 that is currently trading for 85
per 100 of par value. If the bond’s yield to maturity decreases by 50 bps, the expected
percentage price change is closest to:
A. 4.90%.
B. 5.09%.
C. 5.20%.
Q-89. A bond is currently trading for 100.94 per 100 of par value. If the bond’s yield-to-maturity
(YTM) rises by 20 basis points, the bond’s full price is expected to fall to 100.67. If the
bond’s YTM decreases by 20 basis points, the bond’s full price is expected to increase to
101.28. The bond’ s approximate convexity is closest to: ( )
A. 0.34
B. 35.00
C. 173.37
Q-90. Which of the following most likely exhibits negative convexity? (Mock 2016)
A. An option-free bond
B. A callable bond
C. A putable bond.
6.36. Credit Risk and Credit-Related Risk

:
育
6.36.1.
教
6.36.1.1. Credit risk and credit-related risk

程
➢ Credit risk: the risk associated with losses stemming from the failure of a
金
borrower to make timely and full payments of interest or principal. Credit has
two components:
53-80
◼ Default risk: the probability that a borrower fails to pay interest or repay
principal when due.
◼ Loss severity, or loss given fault: is the portion of a bond’s value (including
unpaid interest) an investor loses, in the event of default.
➢ Expected loss = Default probability × Loss severity given default
◼ Loss severity given default = 1 – Recovery rate
➢ Spread risk:
◼ Credit migration (or downgrade risk): this is the risk that a bond issuer’s
creditworthiness deteriorates, or migrates lower, leading investors to
believe the risk of default is higher and thus causing the yield spreads on
the issuer’s bonds to widen and the price of its bonds to fall.
◼ Market liquidity risk: this is the risk that the price at which investors can
actually transact may differ from the price indicated in the market.
6.36.2.
Q-91. The risk that a bond’s creditworthiness declines is best described by:
A. Credit migration risk.

B. Market liquidity risk.
C. Spread widening risk.
Q-92. A company receives a ratings upgrade and the price increases on its fixed-rate bond. The
reason of the price increase was most likely a(n):
A. Decrease in the bond's credit spread.

B. Increase in the bond's liquidity spread.
C. Increase of the bond's underlying benchmark rate.
6.37. Seniority Rankings of Corporate Debt

:
6.37.1.
育
6.37.1.1. Seniority rankings of corporate debt

教
➢ Priority of claims: in the event of default, unsecured debt holders claim rank
程
below (i.e., get paid after) those of secured creditors.

金
◼ Secured debt is backed by collateral
54-80
◼ Unsecured debt (debentures) represents a general claim to the issuer’s
assets and cash flows.
◼ General seniority ranking for debt repayment priority
◆ First lien or first mortgage
◆ Senior secured debt
◆ Junior secured debt
◆ Senior unsecured debt
◆ Senior subordinated debt
◆ Subordinated debt
◆ Junior subordinated debt
➢ All debt within the same category is said to rank pari passu, or have same
priority of claims
6.37.1.2. Pari Passu
➢ All creditors at the same level of the capital structure are treated as one class;
thus, a senior unsecured bondholder whose debt is due in 30 years has the
same pro rata claim in bankruptcy as one whose debt matures in six months.
This provision is referred to as bonds ranking pari passu (“on an equal footing”)
in right of payment.
6.37.2.
Q-93. In the event of default, debentures' claims will most likely rank:
A. above that of secured debt holders.
B. below that of secured debt holders.
C. the same as that of secured debt holders.
Q-94. The Zera Company has borrowed capital by issuing a number of different securities.
Which of the following most likely ranks the highest with respect to priority of payments?
2019 Mock A AM
A. Subordinated loan
:
育
B. Third lien debt

教
C. Senior unsecured bond

程
金
6.38. Credit Rating
6.38.1.
55-80
6.38.1.1. Credit rating
➢ Three major credit ratings agencies: Moody’s, S&P, Fitch
➢ Different credit ratings: Triple A, investment grade(BBB ), non-investment
grade(BB+ )
6.38.1.2. Issuer credit rating and issue ratings

➢ Issuer credit rating (corporate family ratings): a debt issuer’s overall
creditworthiness and typically apply to a firm’s senior unsecured debt.
➢ Issue ratings (corporate credit rating): credit risk of a specific debt issue
6.38.1.3. Notching
➢ Notching: assign different ratings to bonds of the same issuer by rating agencies
◼ Notching is less common for highly rated issuers than for lower-rated
issuers. For lower-rated issuers, higher default risk leads to significant
differences between recovery rates of debt with different seniority
rankings, leading to more notching.
6.38.1.4. Structural subordination
➢ Structural subordination: Arises in a holding company structure when the debt
of operating subsidiaries is serviced by the cash flow and assets of the
subsidiaries before funds can be passed to the holding company to service debt
at the parent level.
6.38.1.5. Cross default provision
➢ Cross default provision: Provisions whereby events of default such as non-
payment of interest on one bond on all outstanding debt; implies the same
default probability for all issues.
6.38.1.6. Risks in relying on agency ratings
➢ Credit ratings are dynamic
➢ Rating agencies are not perfect.
➢ Event risk is difficult to assess.
➢ Credit ratings lag market pricing.
:
育
6.38.2.
教
Q-95. A problem for bond investors relying on credit ratings as a basis for buy and sell decisions
程
is that credit ratings: (2020 Mock B PM)

金
A. are historically inaccurate.

B. can badly lag changes in bond prices.
56-80
C. are less reliable for investment-grade bonds.
Q-96. Which of the following three companies will most likely have notching issues, when they
issue corporate bonds?
A. Company A with AAA rating

B. Company B with AA rating
C. Company C with BBB rating
6.39. Four Cs of Credit Analysis
6.39.1.
6.39.1.1. Four Cs of credit analysis

➢ Capacity
◼ Industry structure
◼ Industry fundamentals
◆ Industry cyclicality
◆ Industry growth prospects
◆ Industry published statistics
◼ Company fundamentals
◆ Competitive position
◆ Ratios and ratio analysis
➢ Collateral
◼ Intangible assets
◆ Patents are considered high-quality intangible assets because they can
be more easily sold to generate cash flows as compared to other
intangibles.
◆ Goodwill is not considered a high-quality intangible asset and is
usually written down when the company performance is poor.
◼ Depreciation
◆ High depreciation expense relative to capital expenditures may signal
:
育
that management is not investing sufficiently in the company.

教
◼ Equity market capitalization

程
◼ Human and intellectual capital

➢
金
Covenants
◼ Affirmative covenant
57-80
◼ Negative covenants
➢ Character
◼ Soundness of strategy
◼ Track record
◼ Accounting policies and tax strategies
◼ Fraud and malfeasance record
6.39.2.
Q-97. Which of the following should be assessed when a credit analyst analyzes the collateral
of a company?
A. Cash flows of the company

B. Soundness of management's strategy
C. Value of the company's assets in relation to the level of debt
Q-98. Which of the following is least likely a component of the "Four Cs of Credit Analysis"
framework? Mock 2018
A. Covenants
B. Competition
C. Collateral
Q-99. Using the "Four Cs of Credit Analysis" framework, which of the following is the least likely
factor to be considered under the category of "capacity"? 2014,2015 Mock PM
A. Industry fundamentals
B. History of fraud or malfeasance
C. Level of competition
6.40. Factors Influence Yield Spreads

:
育
6.40.1.
教
6.40.1.1. yield spread

程
➢ The higher the credit risk, the greater the return potential and the higher the
金
volatility of that return.
58-80
➢ Yield for a given maturity on corporate bond= real interest rate+ expected
inflation rate + liquidity premium + credit spread+ tax impact
◼ It is not possible to directly observe the market’s assessment of the
components separately—analysts can only observe the total yield spread.
➢ Factors affect the spreads on corporate bonds
◼ Credit cycle: credit spreads narrows as the credit cycle improves
◼ Economic conditions: A strengthening economy will cause credit spreads to
narrow
◼ Broker-dealer capital: yield spreads are narrower when broker-dealers
provide sufficient capital
◼ General market demand and supply: credit spreads narrow in times of high
demand for bonds
◼ Financial performance of the issuer: Good news increases the
attractiveness of buying and holding bonds issued by the corporation,
which raises bond prices and narrows spreads.
6.40.2.
Q-100. In which scenario would yields most likely narrow? (2020 Mock B PM)
A. Weak financial markets
B. High demand for bonds
C. Slowdown in market-making activity
Q-101. Which of the following is least likely a component of yield spread? 2017 Mock PM
A. Expected inflation rate

B. Taxation
C. Credit risk
6.41. High Yield, Sovereign, and Municipal Debt

:
6.41.1.
育
6.41.1.1. High yield debt

教
➢ High yield debt=non-investment grade bond=junk bonds(rated below

程
Baa3/BBB-)
金
➢ Special considerations of high-yield credit analysis:

◼ Greater focus on issuer liquidity and cash flow.
59-80
◼ Detailed financial projections.
◼ Detailed understanding and analysis of the debt structure.
◼ Understanding of an issuer’s corporate structure.
◼ Covenant analysis.
6.41.1.2. Sovereign debt
➢ The basic framework for evaluating sovereign credit and assigning sovereign
debt ratings:
◼ Institutional effectiveness and political risks
◼ Economic structure and growth prospects
◼ External liquidity and international investment position
◼ Fiscal performance, flexibility, and debt burden
◼ Monetary flexibility.
6.41.1.3. Municipal debt
➢ GO bonds
◼ backed by the taxing authority of the issuing municipality.
◼ The credit analysis has some similarities to sovereign analysis.
➢ Revenue bonds
◼ Support specific projects, such as toll roads, bridges, airports, and other
infrastructure.
◼ The creditworthiness comes from the revenues generated by usage fees
and tolls levied.
◼ Often have higher credit risk than GO bonds.
◼ Analysis of revenue bonds is similar to those for analyzing corporate bonds.
6.41.2.
Q-102. Which of the following factors in credit analysis is more important for general obligation
non-sovereign government debt than for sovereign debt? ( )
A. Per capita income

B. Power to levy and collect taxes
:
育
C. Requirement to balance an operating budget

教
程
金
60-80
:
育
教
程
金
61-80
Solutions
:
育
教
程
金
62-80
:
育
教
程
金
63-80
6. Fixed Income
6.1.
Q-1. Solution: C.
A capital market security has an original maturity longer than one year.
Q-2. Solution: A.
A dual currency bond makes coupon payments in one currency and pays the par value at maturity
in another currency.
Q-3. Solution: A.
Bonds issued by entities that are incorporated in another country are called foreign bonds.
Therefore, the bonds issued by a South Korean company in the United States are known as foreign
bonds.
Q-4. Solution: C.
C is correct. Agency bonds are issued by quasi-government entities. These entities are agencies
and organizations usually established by national governments to perform various functions for
them.
Q-5. Solution: C.
Supranational bonds are bonds issued by such supranational agencies as the European Investment
Bank and the International Monetary Fund.
Q-6. Solution: C.
Securitized bonds typically rely on the cash flows generated by one or more underlying financial
assets as the primary source of the contractual payments to bondholders rather than on the
claims-paying ability of the operating entity.
Q-7. Solution: C.
:
Overcollateralization is a form of internal credit enhancement in which more collateral is posted

育
than is needed to obtain or secure financing. It provides an additional credit buffer in the event of
教
default by providing more assets to repay the lender.

程
金
Q-8. Solution: C.
64-80
The third-party (or counterparty) risk for a surety bond and a letter of credit arises from both future
promises to pay. In contrast, a cash collateral account allows the issuer to immediately borrow the
credit-enhancement amount and then invest it.
Q-9. Solution: B.
Prohibiting the issuer from investing in risky projects restricts the issuer's potential business
decisions. This restriction is referred to as negative bond covenants.
Q-10. Solution: A.
Paying interest and principal is one of the most common affirmative covenants. Negative covenants
set forth certain limitations and restrictions on the borrower’s activities. The more common
restrictive covenants are those that impose limitations on the borrower’s ability to incur additional
debt, such as specifying a debt-to-capital ratio, unless certain tests are satisfied.
Q-11. Solution: A.
An original issue discount tax provision allows the investor to increase the cost basis of the bond,
so when the bond matures, the investor faces no capital gain or loss.
Q-12. Solution: B.
A fully amortizing mortgage is least likely to contain a balloon payment because the sum of all the
scheduled principal repayments during the mortgage’s life is such that when the last mortgage
payment is made the loan is paid in full.
Q-13. Solution: C.
Except at maturity, the principal repayments are lower for a partially amortized bond than for an
otherwise similar fully amortized bond. Consequently, the principal amounts outstanding and,
therefore, the amounts of interest payments are higher for a partially amortized bond than for a
fully amortized bond, all else equal. The only exception is the first interest payment, which is the
same for both repayment structures. This is because no principal repayment has been made by the
time the first coupon is paid.
:
育
Q-14. Solution: A.
教
A sinking fund arrangement is a way to reduce credit risk by making the issuer set aside funds over
程
time to retire the bond issue.

金
Q-15. Solution: B.
65-80
There are no interim cash flows for a zero-coupon bond until the maturity.
Q-16. Solution: A.
An FRN with a floor on the coupon rate prevents the coupon rate from falling below a pre-specified
minimum rate.
Q-17. Solution: B.
LIBOR + 300 bps at the reset date is 1.5% + 3.00% = 4.5%, which is below the floor of 5.00%, so the
coupon rate will be equal to the floor.
Q-18. Solution: B.
Capital-indexed bonds pay a fixed coupon rate that is applied to a principal amount that increases
in line with increases in the index during the bond's life. If the consumer price index increases by
6%, the coupon rate remains unchanged at 8%, but the principal amount increases by 6%/2=3%
and the coupon payment is based on the inflation-adjusted principal amount. On the first coupon
payment date, the inflation-adjusted principal amount is 1,000 × (1 + 0.03) = 1,030 and the semi-
annual coupon payment is equal to (0.08 × 1,030) / 2 = 41.20.
Q-19. Solution: A.
A step-up coupon bond has contractually mandated changes in its coupon rate over time.
Q-20. Solution: B.
A put feature is beneficial to the bondholders. Thus, the price of a putable bond will typically be
higher than the price of an otherwise similar non-putable bond.
Q-21. Solution: A.
The conversion value of the bond is 50,000 40 = $2,000,000. The price of the convertible bond
is $1,800,000. Thus, the conversion value of the bond is more than the bond's price, and this
condition is referred to as above parity.
:
育
Q-22. Solution: B.
教
When interest rates fall, the price of the embedded call option increases. The price of a callable
程
bond equals the price of an option-free bond minus the price of the embedded call option. So, the
金
price of the callable bond will not increase as much as an option-free bond because the price of
66-80
the call option increases. As interest rates fall, the bond is more likely to be called, limiting the
upside potential of price.
Q-23. Solution: A.
Callable bonds give issuers the ability to retire debt prior to maturity. The most compelling reason
for them to do so is to take advantage of lower borrowing rates.
Q-24. Solution: A.
An American-style callable bond is a bond in which the issuer has the right to call the bonds at any
time starting on the first call date.
Q-25. Solution: A.
Primary bond markets are markets in which bonds are issued for the first time to raise capital.
Q-26. Solution: A.
In major developed bond markets, newly issued sovereign bonds are sold to the public via an
auction.
Q-27. Solution: C.
Non-sovereign bonds usually trade at a higher yield and lower price than sovereign bonds with
similar characteristics. The higher yield is because of the higher credit risk associated with non-
sovereign issuers relative to sovereign issuers, although default rates of local governments are
historically low and their credit quality is usually high. The higher yield may also be a consequence
of non-sovereign bonds being less liquid than sovereign bonds with similar characteristics.
Q-28. Solution: B.
The IMF is a multilateral agency that issues supranational bonds.
Q-29. Solution: B.
A loan from a group of lenders to a single borrower is a syndicated loan.
:
育
Q-30. Solution: C.
教
The longer the length of the repurchase agreement, the higher the repo margin (haircut).
程
金
Q-31. Solution: B
67-80
A syndicated loan is a loan from a group of lenders, called the "syndicate," to a single borrower.
Syndicated loans are primarily originated by banks, and the loans are extended to companies but
also to governments and government-related entities.
Q-32. Solution: B.
A repurchase agreement (repo) can be viewed as a collateralized loan where the security sold and
subsequently repurchased represents the collateral posted.
Q-33. Solution: A.
If the credit event does not occur, the issuer must make all promised cash flows as scheduled- that
is, the regular coupon payments and the par value at maturity.
Q-34. Solution: C.
A structured financial instrument whose coupon rate moves in the opposite direction of the
reference rate is called an inverse floater. Because the coupon leverage (0.5) is greater than zero
but lower than one, the structured financial instrument is a deleveraged inverse floater. In this
example, if the reference rate increases by 100 bps, the coupon rate decreases by 50 bps.
Q-35. Solution: A.
The bond price is closest to 95.00. The bond has six semiannual periods. Half of the annual coupon
is paid in each period with the required rate of return also being halved. The price is determined
in the following manner:
N=6, I/Y=5.5, PMT=4.5, FV=100
CPT (PV)=95
Q-36. Solution: C.
The lower the coupon rate, the more sensitive the bond’s price is to changes in interest rates.
Q-37. Solution: B.
The formula for calculating this bond’s yield-to-maturity is:
:
育
N=40, PV=-111, PMT=2.5, FV=100

CPT (I/Y)=2.09(%)
教
2.09*2=4.18(%)
程
金
Q-38. Solution: B.
68-80
The value of the bond is
10 10 110
+ 2
+ = 9.43 + 8.90 + 92.36 = 110.69
1.06 1.06 1.063
if market interest rates increase, the discount rate will increase, and the value will be
10 10 110
+ 2
+ = 9.26 + 8.57 + 87.32 = 105.15
1.08 1.08 1.083
a change of 105.15-110.69=-5.54.
Q-39. Solution: B.
The bond price is closest to 100.32.
PV=(10 / 1.08) + (10 / (1.09)2) + (110 / (1.10)3) = 100.32
Q-40. Solution: C.
A spot rate is defined as the yield to maturity on a zero-coupon bond maturing at the date of that
cash flow.
Q-41. Solution: C.
If the discount rate increases to 12% from 8%, the price of a bond decreases. At a discount rate of
12%, the bond sells at a discount to face value. As a discount bond approaches maturity, it will
increase in price over time until it reaches par at maturity.
Q-42. Solution: B.
With 4 years remaining to maturity and a discount rate that is unchanged at 6.0 percent, the value
of the bond would be $103.47 or N=4, I/Y=6, PMT=7, FV=100, CPT(PV)=103.47, the part of this
change in value attributing to the passage of time is 104.21-103.47=0.74.
Q-43. Solution: A.
Bond dealers usually quote the flat price. When a trade takes place, the accrued interest is added
to the flat price to obtain the full price paid by the buyer and received by the seller on the
:
settlement date. The reason for using the flat price for quotation is to avoid misleading investors
育
about the market price trend for the bond. If the full price were to be quoted by dealers, investors
教
would see the price rise day after day even if the yield-to-maturity did not change. That is because
程
the amount of accrued interest increases each day. Then after the coupon payment is made the
金
quoted price would drop dramatically. Using the flat price for quotation avoids that
misrepresentation.
69-80
Q-44. Solution: C.
4 4 4 4 104
PV = + + + + = 104.58
(1 + 0.03)1 (1 + 0.03)2 (1 + 0.03)3 (1 + 0.03)4 (1 + 0.03)5
PV full = 104.58 × 1.0376/180 = 105.89
Q-45. Solution: C.
Matrix pricing is most suited to pricing inactively traded bonds and newly underwritten bonds. A
credit analyst is least likely to use matrix pricing to price an actively traded bond.
Q-46. Solution: A.
The first step is to determine the yields-to-maturity on the observed bonds. The required yield on
the two-year, 6.0% bond priced at 106.500 is 2.622%. The required yield on the four-year, 5.0%
bond priced at 106.250 is 3.306%.
Applying the method of linear interpolation, the YTM of a bond with three-year maturity and same
credit ranking is (2.622%+3.306%)/2=2.964%, then calculate the price, which is 105.763.
Some fixed-rate bonds are not actively traded. Therefore, there is no market price available to
calculate the rate of return required by investors. The same problem occurs for bonds that are not
yet issued. In these situations, it is common to estimate the market discount rate and price based
on the quoted or flat prices of more frequently traded comparable bonds. These comparable bonds
have similar times-to-maturity, coupon rates, and credit quality. This estimation process is called
matrix pricing.
Q-47. Solution: B.
Current yield is calculated as ($6/$92.50) = 6.49%.
Q-48. Solution: C.
180
PV = 100 × (1 − × 0.0650) = 96.75
360
365 100 − 96.75
BEY = × = 6.81%
180 96.75
:
育
Q-49. Solution: C.
教
FRN Z will be priced at a discount on the next reset date because the quoted margin of 0.80% is
程
less than the discount or required margin of 0.85%. The discount amount is the present value of
金
the extra or "excess" interest payments of 0.05% (0.85% - 0.80%). FRN Y will be priced at par value
70-80
on the next reset date since there is no difference between the quoted and discount margins. FRN
X will be priced at a premium since the quoted margin is greater than the required margin.
Q-50. Solution: C.
C is correct. The yield-to-call is 4.68%, the formula for calculating this bond’s yield-to -call is:
N=6, PV=-990, PMT=20, FV=1010
CPT (I/Y)=2.338（%）
YTC=I/Y*2=4.68（%）
Q-51. Solution: B.
The spot curve, also known as the strip or zero curve, is the yield curve constructed from a
sequence of yields-to-maturities on zero-coupon bonds. The par curve is a sequence of yields-to-
maturity such that each bond is priced at par value. The forward curve is constructed using a series
of forward rates, each having the same time frame.
Q-52. Solution: A.
To obtain the spot yield curve a bond analyst would prefer to use the most recently issued and
actively traded government bonds. Such bonds will have similar liquidity as well as fewer tax effects
because they will be priced closer to par value.
Q-53. Solution: B.
The forward and spot curves are interconnected to each other. The spot curve can be calculated
from the forward curve, and the forward curve can be calculated from the spot curve. Either curve
can be used to value fixed-rate bonds.
Q-54. Solution: B.
The value of the bond is
3 3
+
(1 + 0.015/2) (1 + 0.015/2) ∗ (1 + 0.025/2)
3
+
:
0.025
(1 + 0.015/2) ∗ (1 +
2 ) ∗ (1 + 0.033/2)
育
教
3
+
0.025 0.033
程
(1 + 0.015/2) ∗ (1 + ∗ + ∗ (1 + 0.039/2)
2 ) (1 2 )
金
3 + 100
+
0.025 0.033 0.039
(1 + 0.015/2) ∗ (1 +
2 ) ∗ (1 + 2 ) ∗ (1 + 2 ) ∗ (1 + 0.043/2)
71-80
= $107.03
Q-55. Solution: A.
The four-year spot rate can be computed as:
Z4=[(1.005)×(1.007)×(1.01)×(1.015)]1/4-1=0.924%
Q-56. Solution: A.
Solution 1 Yield-to-maturity on the U.K. corporate bond:
5 5 105
100.65 = + + , r = 0.04762 or 476bps
(1 + r )1 (1 + r ) 2 (1 + r )3
Yield-to-maturity on the U.K. government benchmark:
2 2 102
100.25 = + + , r = 0.01913 or 191bps
(1 + r ) (1 + r )
1 2
(1 + r )3
The G-spread is 476-191=285 bps
Solution 2 FV=100, PV=-100.25, N=3, PMT=2%×100=2, CPT, I/Y=1.91, rtreasury=191bps
FV=100, PV=-100.65, N=3, PMT=5%×100=5, CPT, I/Y=4.76, rbond=476bps

The G-spread is rbond - rtreasury =285 bps
Q-57. Solution: A.
The I-spread, or interpolated spread, is the yield spread of a specific bond over the standard swap
rate in that currency of the same tenor. The yield spread in basis points over an actual or
interpolated government bond is known as the G-spread. The Z-spread (zero-volatility spread) is
the constant spread that is added to each spot rate so that the present value of the cash flows
matches the price of the bond.
Q-58. Solution: C.
A key motivation for a corporation to establish a SPV is to separate it as a legal entity. In the case
of bankruptcy for the corporation, the SPV is unaffected because it is not a subsidiary of the
corporation. Given this arrangement, the SPV can achieve a rating as high as AAA and borrow at
:
lower rates than the corporation.

育
教
Q-59. Solution: B.
程
There are recourse and non-recourse mortgage loans. In a non-recourse loan, the lender does not
金
have a claim against the borrower and thus can look only to the property to recover the
outstanding mortgage balance. In a recourse loan, the lender can seek to recover any shortfall from
72-80
the sale of the property to cover the mortgage loan. The borrower, therefore, has a strategic default
option only in non-recourse loans; for example, if the mortgage is greater than the property value,
he may select to default without further personal obligation.
Q-60. Solution: C.
In a mortgage pass-through security the pass-through rate is less than the mortgage rate on the
underlying pool of mortgages by an amount equal to the servicing (and other administrative)
fees.
Q-61. Solution: A.
Extension risk (contraction risk) is the risk that when interest rates rise (decline), actual
prepayments will be lower (higher) than forecasted. At lower rates, homeowners will refinance at
the now-available lower interest rates. Thus, a security backed by mortgages will have a shorter
maturity than was anticipated at the time of purchase. At higher rates, homeowners are reluctant
to give up the benefits of a contractual interest rate that now looks low, thus slowing the
prepayment on the securitization, leading to its longer maturity. SMM is a measure of prepayment
and not a risk, and CPR is the corresponding annualized rate.
Q-62. Solution: C.
Seasoned means that the pool is older than 30 months.
SMM=1-(1-0.06)1/12=0.005143.
Q-63. Solution: A.
The lower and upper PSA prepayment assumptions are called the “initial PAC collar”. If the
prepayment speed is slower than lower limit of initial collar, the support tranche receives a lower
level of prepayments, even no cash flow received and the PAC tranche also receives a lower level
of prepayments. The average life of the support tranche and the PAC tranche will extend (lengthen).
Q-64. Solution: B
Credit tranching allows investors to choose between subordinate and senior bond classes as a
:
育
means of credit enhancement. The purpose of this structure is to redistribute the credit risk
associated with the collateral.
教
程
Q-65. Solution: A.
金
Asset-backed securitizations can be structured with subordinated bond classes. They function as
credit protection for the more senior bond classes; that is, losses are realized by the subordinated
73-80
bond classes before any losses are realized by the senior bond classes. This type of protection is
also commonly referred to as a waterfall structure because of the cascading flow of payments
between bond classes in the event of default.The creation of bond classes that possess different
expected maturities is referred to as time tranching. An SPE is a bankruptcy remote legal entity
that holds the collateral and is considered not an enhancement but, rather, a prerequisite for
establishing securitizations.
Q-66. Solution: A.
Because commercial mortgage loans are non-recourse loans, the lender can only look to the
income-producing property backing the loan for interest and principal repayment. If there is a
default, the lender looks to the income-producing property backing the loan for interest and
principal repayment. If there is a default, the lender looks to the proceeds from the sale of the
property for repayment and has no recourse against the borrower for any unpaid mortgage loan
balance.
Q-67. Solution: C.
A structural call protection can be achieved in a CMBS when it is structured to have sequential-
pay tranches by credit rating.
Q-68. Solution: A.
An auto loan ABS involves the use of amortizing collateral, that is, the cash flows for an auto loan
ABS include interest payments, scheduled principal repayments, and any prepayments, if allowed.
Q-69. Solution: B.
A credit card receivable ABS is an example of an ABS with a non-amortizing collateral. A credit card
receivable ABS may require early amortization of the principal if certain events occur. Such an early
amortization provision would safeguard the credit quality of the issue. And a credit card receivable
ABS would typically have a lockout period during which the cash flow that is paid out to security
holders is based only on finance charges collected and fees.
:
育
Q-70. Solution: B.
Unlike a traditional asset-backed security, an arbitrage collateralized debt obligation involves active
教
management because the CDO manager buys and sells debt obligations with the objective of
程
paying off different classes of bondholders as well as generating a high return for the
金
subordinated/equity tranche and the manager.
74-80
Q-71. Solution: B.
Covered bonds usually carry lower credit risks and offer lower yields than otherwise similar ABS.
The reason is, among other factors, covered bonds provide investors with dual recourse, to the
cover pool and also to the issuer. Moreover, covered bonds have a dynamic cover pool, meaning
sponsors must replace any prepaid or non-performing assets.
Q-72. Solution: C.
8 8 8 108
PV = 1
+ 2
+ 3
+ = 93.66
1.1 1.1 1.1 1.14
Coupon & coupon reinvestment = 8 × 1.14 + 8 × 1.13 + 8 × 1.12 + 8 × 1.11 + 8 = 48.84
93.66 + 48.84
100 = , 𝑟 = 0.0734
(1 + 𝑟)5
Q-73. Solution: C.
The realized horizon yield will equal the original yield to maturity if the coupon payments are
reinvested at the original yield to maturity and the bond is sold at a price on the constant-yield
price trajectory. The latter condition ensures that the investor does not have any capital gains or
losses when the bond is sold.
Q-74. Solution: B.
period Cash flow Present value weight Period×weight
1 60 55.55556 0.058575 0.058575
2 60 51.44033 0.054236 0.108471
3 1060 841.46218 0.887190 2.661570
948.45806 1.000000 2.828617
Q-75. Solution: B.
When interest rates are rising, the put option becomes more valuable to the investor. The ability
to sell the bond at par value limits the price depreciation as rates rise. So, the presence of an
embedded put option reduces the sensitivity of the bond price to changes in interest rates,
:
resulting in a lower effective duration.

育
教
Q-76. Solution: B.
程
The effective duration is defined as:

金
(𝑃𝑉− ) − (𝑃𝑉+)
2 ∗ (∆𝐶𝑢𝑟𝑣𝑒) ∗ (𝑃𝑉0 )
Effective duration = (106.75 – 102.10)/(2 × 0.0035 × 103.25)= 6.43

75-80
Q-77. Solution: B.
To determine the percentage price change of a bond for a given change in yield, first convert
Macaulay duration (7.0705) to modified duration by dividing Macaulay duration by 1 plus yield per
period.
ModDur =7.0705/1.047 = 6.7531
Next, multiply annual modified duration by the change in yield.
–[6.7531 × (–0.0075)] = 0.0507 or 5.07%
Q-78. Solution: C.
Option-free bonds have positive convexity. The higher the yield to maturity, the lower the duration
(and thus the lower the interest rate risk).
Q-79. Solution: A.
The presence of an embedded put option reduces the effective duration of the bond, especially
when rates are rising. If interest rates are low compared with the coupon rate, the value of the put
option is low and the impact of the change in the benchmark yield on the bond's price is very
similar to the impact on the price of a non-putable bond. But when benchmark interest rates rise,
the put option becomes more valuable to the investor. The ability to sell the bond at par value
limits the price depreciation as rates rise. The presence of an embedded put option reduces the
sensitivity of the bond price to changes in the benchmark yield, assuming no change in credit risk.
Q-80. Solution: B.
Money Duration of Bond A = 7.5 × 95.00 = 712.50
Money Duration of Bond B = 5.5 × 85.00 = 467.50
Money Duration of Bond C = 10 × 90.00 = 900
The total market value of the bond portfolio is 180,000 + 100,000 + 120,000 = 400,000.
The portfolio duration is 712.50 × (180,000/400,000) + 467.50 × (100,000/400,000) + 900 ×
(120,000/400,000) = 707.50.
:
育
Q-81. Solution: A.
A limitation to using the average duration approach in calculating portfolio duration is that it
教
assumes all interest rates across the yield curve change by the same amount and, therefore, each
程
bond’s price changes by the same percentage.

金
Q-82. Solution: C.
76-80
The bond's PVBP is computed using
(PV− )−( PV+ )
PVBP = .
2
105.90 − 105.75
= 0.075
2
Q-83. Solution: A.
A lower coupon rate means that more of the bond’s value comes from repayment of face value,
which occurs at the end of the bond’s life.
Q-84. Solution: C.
Empirical duration is the best measure—better than analytical duration—of the impact of yield
changes on portfolio value, especially under stressed market conditions, for a portfolio consisting
of a variety of different bonds from different issuers, such as the portfolio described in Answer C.
In this portfolio, credit spread changes on the high-yield bonds may partly or fully offset yield
changes on the AAA rated sovereign bonds and spread changes on the AAA rated corporate bonds;
this interaction is best captured using empirical duration. The portfolios described in Answers A
and B consist of the same types of bonds from similar issuers—sovereign bonds from similar-rated
sovereign issuers (A) and covered bonds from similar-rated corporate issuers (B)—so empirical and
analytical durations should be roughly similar in each of these portfolios.
Q-85. Solution: C
When the investment horizon is greater than the Macaulay duration of the bond, coupon
reinvestment risk dominates market price risk and the investor is at risk of lower interest rates.
Q-86. Solution: B
The duration gap is the bond’s Macaulay duration minus the investment horizon, which is
positive in this case. A positive duration gap implies that the investor is currently exposed to the
risk of higher interest rates.
Q-87. Solution: C.
:
育
A fall in interest rates will result in a higher percentage rise in the bond’s price compared with the
教
percentage fall in the bond’s price when interest rates rise by the same amount.
程
金
Q-88. Solution: B.
The expected percentage price change for a bond can be is estimated as follows:
%ΔPFull ≈ (–AnnModDur × ΔYield) + [0.5 × AnnConvexity × (ΔYield)2]
77-80
%ΔPFull ≈ (–10 × –0.005) + [0.5 × 75× (–0.005)2] = 5.09%
Q-89. Solution: C.
approximate convexity =
[101.28 + 100.67 − (2 ∗ 100.94) ]⁄( 0.0022 ∗ 100.94) = 173.37
Q-90. Solution: B.
A callable bond exhibits negative convexity at low yield levels and positive convexity at high yield
levels.
Q-91. Solution: A.
Credit migration risk or downgrade risk refers to the risk that a bond issuer's creditworthiness may
deteriorate or migrate lower. The result is that investors view the risk of default to be higher,
causing the spread on the issuer's bonds to widen.
Q-92. Solution: A.
The price increase was most likely caused by a decrease in the bond's credit spread. The ratings
upgrade most likely reflects a lower expected probability of default and/or a greater level of
recovery of assets if default occurs. The decrease in credit risk results in a smaller credit spread.
The increase in the bond price reflects a decrease in the yield-to-maturity due to a smaller credit
spread. The change in the bond price was not due to a change in liquidity risk or an increase in the
benchmark rate.
Q-93. Solution: B.
Secured debt holders have a direct claim on certain assets and their associated cash flows whereas
unsecured debt holders only have a general claim on the issuer's assets and cash flow.
Q-94. Solution: B.
Third lien debt is secured debt. It has a secured interest in the pledged assets and ranks higher than
all other unsecured debts.
:
育
A is incorrect because a subordinate loan is an unsecured debt. Among the various creditor classes,
these obligations have among the lowest priority of claims and frequently have little or no recovery
教
in the event of default.

程
C is incorrect because senior unsecured bond is also an unsecured debt. It ranks highest among all
金
the unsecured debts, but it ranks below secured debts.
78-80
Q-95. Solution: B.
In response to changes in perceived creditworthiness, bond prices and credit spreads often move
more quickly than rating agencies change their ratings up or down. Bond prices and relative
valuations can move every day, whereas bond ratings do not change very often. Thus, bond
investors who wait for rating agencies to change their ratings before making buy and sell decisions
in their portfolios may be at risk of underperforming other investors who make portfolio decisions
in advance of rating agency changes.
Q-96. Solution: C.
Notching is less common for highly rated issuers than for lower-rated issuers. For lower-rated
issuers, higher default risk leads to significant differences between recovery rates of debt with
different seniority rankings, leading to more notching.
Q-97. Solution: C.
The value of assets in relation to the level of debt is important to assess the collateral of the
company; that is, the quality and value of the assets that support the debt levels of the company.
Q-98. Solution: B.
B is correct. The “Four Cs of Credit Analysis” framework includes capacity, collateral, covenants,
and character. Competition is not one of the components.
Q-99. Solution: B.
Any history of fraud or malfeasance is a major warning flag to credit analysis under the category of
"character."
Q-100. Solution: B.
In periods of high demand, bond prices will increase and yields will decrease (since bond price and
yield are inversely related); consequently, yield spreads (the difference in yield between a
corporate bond and default-free bond) will tighten (narrow).
:
育
Q-101. Solution: A.
Building blocks of the yield curve are spread (risk premium) and a benchmark (risk-free rate of
教
return). Expected inflation rate and expected real rate are components of the risk-free rate of
程
return (i.e., the benchmark).

金
Q-102. Solution: C.
79-80
C is correct. Non-sovereign governments typically must balance their operating budgets and lack
the discretion to use monetary policy as many sovereigns can.
:
育
教
程
金
80-80

Fixed Income 6.1. Basic Features of A Fixed-Income Security 6.1.1. 6.1.1.1. Basic Features of A Fixed-Income Security

Uploaded by

Copyright:

Available Formats

Fixed Income 6.1. Basic Features of A Fixed-Income Security 6.1.1. 6.1.1.1. Basic Features of A Fixed-Income Security

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Fixed Income 6.1. Basic Features of A Fixed-Income Security 6.1.1. 6.1.1.1. Basic Features of A Fixed-Income Security

Uploaded by

Copyright:

Available Formats

6.

6.1.1.1. basic features of a fixed-income security

Q-1. A sovereign bond which has a maturity of 15 years can be described as a:

B. pure discount bond.

6.2. Sectors of the Bond Market

6.2.1.1. Sectors of the bond market

6.3.1.1. Issuing entities:

Types of bond Source of repayment

Supranational ◼ Repayment of previous loans

◼ General taxing authority of issuer

Corporate bonds ◼ Cash flows from operations

◼ Cash flows generated by one or more

Q-4. Agency bonds are issued by:

A. claims-paying ability of the operating entity.

6.4. Collateral and Credit Enhancements

Collateral trust bonds Financial assets

Equipment trust Specific types of equipment or physical assets (e.g.

certificates railroad cards, oil drilling)

short-term commercial paper. A cash collateral account mitigates investors’

meet its obligation.

A. Letter of credit 2019 mock

6.5. Bond Indenture, Affirmative and Negative Covenants

6.5.1.1. functions of a bond indenture

6.5.1.2. negative covenants affirmative covenants

➢ Negative covenants: frequently costly and do materially constrain the issuer's

A. required to pay taxes as they come due.

B. prohibited from investing in risky projects.

6.6. Taxation of Bond Income

6.6.1.1. Tax consideration

6.7. Cash Flow Structure

6.7.1.1. Principal repayment structure

✓ Another potential disadvantage for investors occurs if the issuer

has the option to repurchase bonds at below market prices.

➢ Coupon payment structure

Floating-rate notes: coupon rates that are adjusted based on a reference

maturity, and the inflation adjustment applies to the interest

◆ Capital-indexed bonds: pay a fixed coupon rate but it is applied to a

principal amount that increases in line with increases in the index

during the bond’s life.

amortized bond are:

A. Sinking fund arrangement 2016 mock

B. Floating rate note

FRN is most likely referred to as a: 2014 Mock AM / 2016,2017 Mock PM

Year 1-Year LIBOR

1 Jan 2018–31 Dec 2019 7.50%

1 Jan 2020–31 Dec 2023 9.00%

The security is most likely a (n): 2019 AM Mock

B. deferred coupon bond.

6.8.1.1. Callable bond

6.8.1.3. Convertible bond

➢ Conversion option: (benefit bondholders) allow the bondholder to exchange

bonds for a specified number of shares of the issuer’s common stock.

conversion condition for this bond is:

price of a callable bond will: 2014 Mock PM

lower borrowing rates, it most likely issues a: 2015 Mock AM

6.9. Primary Market and Secondary Market

6.9.1.1. Primary market

offering circular for each bond issue.

➢ Private placement: sale of an entire issue to a qualified investor or a group of