CFA Fixed Income Syllabus

What is a step-up coupon bond?

A bond whose coupon rate increases by predetermined amounts at scheduled dates over the bond's life. Step-ups are often linked to call features or credit-rating triggers.

Define a deferred-coupon (split-coupon) bond.

A bond that pays no coupons for an initial period, then begins paying (often higher) coupons. Useful for issuers expecting low early cash flows, such as project financings.

What is a payment-in-kind (PIK) bond?

A bond that allows the issuer to pay coupons with additional bonds (or increased principal) rather than cash. PIK bonds are common among highly leveraged issuers with limited cash.

What is an index-linked (inflation-linked) bond?

A bond whose principal and/or coupon payments are adjusted for changes in a price index (e.g. CPI), protecting the investor's real return against inflation. Example: US TIPS.

Distinguish a callable bond from a putable bond.

Callable: the issuer has the right to redeem the bond early (benefits issuer, hurts investor). Putable: the investor has the right to sell the bond back to the issuer early (benefits investor).

How does an embedded call option affect a bond's value and yield relative to an otherwise identical option-free bond?

$$P_{\text{callable}} = P_{\text{option-free}} - P_{\text{call option}}$$ The call lowers the bond's price and therefore raises its yield to compensate investors for the issuer's option.

How does an embedded put option affect a bond's value relative to an option-free bond?

$$P_{\text{putable}} = P_{\text{option-free}} + P_{\text{put option}}$$ The put raises the bond's price and lowers its yield, because the option benefits the investor.

What is a convertible bond?

A bond that gives the holder the right to convert it into a predetermined number of the issuer's common shares. It combines fixed-income features with equity upside, typically at a lower coupon.

Define the conversion value of a convertible bond.

$$\text{Conversion Value} = \text{Conversion Ratio} \times \text{Share Price}$$ It is the value of the bond if converted immediately into shares.

What is a sinking fund provision?

A provision requiring the issuer to retire a portion of the bond's principal on a schedule before maturity, reducing credit risk to investors by ensuring gradual repayment.

What are the main issuers of fixed-income securities?

Sovereign (national) governments, non-sovereign/local governments (municipalities), quasi-government agencies, supranational organizations, and corporations (financial and non-financial).

What are sovereign bonds?

Bonds issued by a national government, denominated in its own or a foreign currency (e.g. US Treasuries, UK Gilts, German Bunds). Local-currency sovereigns of stable governments are often considered low default risk.

What distinguishes Treasury bills, notes, and bonds by maturity in the US?

T-bills: $\leq 1$ year, zero-coupon (issued at discount). T-notes: $2$–$10$ years, coupon-paying. T-bonds: $> 10$ up to $30$ years, coupon-paying.

What are supranational bonds?

Bonds issued by multilateral institutions owned by multiple national governments, such as the World Bank, IMF, or European Investment Bank, typically carrying very high credit quality.

What is the difference between a general obligation (GO) bond and a revenue bond?

GO bonds are municipal bonds backed by the full faith, credit, and taxing power of the issuer. Revenue bonds are serviced only by the cash flows of a specific project (e.g. a toll road) and carry higher risk.

What is a corporate bond's seniority ranking from highest to lowest claim?

Secured (senior secured) $>$ senior unsecured $>$ senior subordinated $>$ subordinated $>$ junior subordinated. Higher-ranked claims are paid first in default/liquidation.

What are asset-backed securities (ABS) and mortgage-backed securities (MBS)?

Securities created by pooling financial assets (mortgages for MBS; auto loans, credit-card receivables, etc. for ABS) and issuing bonds backed by the pool's cash flows through securitization.

What is securitization and one key benefit?

Securitization pools illiquid assets (e.g. loans) and issues tradable securities backed by them. A key benefit is that it removes intermediation, potentially lowering funding costs and giving investors direct exposure to diversified asset pools.

Define interest rate risk for a bond.

Interest rate risk is the risk that a bond's price will change due to changes in market interest rates. Bond prices and yields move inversely: rising rates lower prices and vice versa.

State the inverse and convex relationship between bond price and yield.

Price and yield move inversely, and the price-yield curve is convex: for a given yield change, the price increase from a yield drop exceeds the price decrease from an equal yield rise.

What is Macaulay duration?

Macaulay duration is the weighted-average time (in periods/years) to receive a bond's cash flows, with weights equal to each cash flow's present value as a fraction of price. It is measured in years.

How is modified duration related to Macaulay duration?

$$D_{\text{mod}} = \frac{D_{\text{Mac}}}{1 + \frac{y}{m}}$$ where $y$ is the annual yield and $m$ the number of compounding periods per year. Modified duration estimates percentage price sensitivity to yield changes.

Give the approximate percentage price change formula using modified duration.

$$\frac{\Delta P}{P} \approx -D_{\text{mod}} \times \Delta y$$ A first-order (linear) estimate of the bond's price change for a small yield change $\Delta y$.

Write the formula for approximate (effective) duration using price shifts.

$$D_{\text{eff}} = \frac{P_{-} - P_{+}}{2 \times P_{0} \times \Delta y}$$ where $P_{-}$ and $P_{+}$ are prices when yield falls and rises by $\Delta y$, and $P_{0}$ is the initial price.

What is convexity and why is it added to a duration-based estimate?

Convexity measures the curvature of the price-yield relationship. Because duration alone underestimates the true price for large yield moves, adding a convexity term corrects the estimate. Higher convexity is beneficial to bondholders.

Give the duration-plus-convexity estimate of a bond's price change.

$$\frac{\Delta P}{P} \approx -D_{\text{mod}}\,\Delta y + \tfrac{1}{2}\,C\,(\Delta y)^{2}$$ where $C$ is convexity.

How do coupon rate and maturity affect a bond's interest rate sensitivity (duration)?

Duration (interest rate sensitivity) is higher for lower coupon rates and for longer maturities. Zero-coupon bonds of a given maturity have the highest duration (equal to their maturity).

What is a bond's price value of a basis point (PVBP)?

PVBP (or DV01) is the absolute change in a bond's price for a $1$ basis point ($0.01\%$) change in yield: $$\text{PVBP} = \frac{P_{-} - P_{+}}{2}$$ for a $1$ bp shift.

Define credit (default) risk and its two main components.

Credit risk is the risk of loss from a borrower failing to make promised payments. Its components are default risk (probability of default) and loss severity/loss given default (magnitude of loss if default occurs).

Distinguish investment-grade from high-yield (speculative) bonds by rating.

Investment grade: rated $\text{Baa3/BBB-}$ or higher (Moody's/S&P). High-yield (junk): rated $\text{Ba1/BB+}$ or lower. The boundary separates lower- from higher-default-risk issuers.

What is a credit spread and how does it typically behave in a recession?

A credit spread is the yield difference between a risky bond and a comparable-maturity default-free bond, compensating for credit risk. Spreads widen in recessions (rising perceived risk) and narrow in expansions.