Chartered Financial Analyst (CFA) Fixed Income, Derivatives, and Alternatives Syllabus

Fixed Income, Derivatives, and Alternatives syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Fixed Income, Derivatives, and Alternatives in Chartered Financial Analyst (CFA), not a summary of it.

1. 1

   Fixed-Income Fundamentals

   3 topics

   • Fixed-Income Instrument Features
     • Bond indenture, covenants, and cash flow structures
     • Contingency provisions: callable, putable, convertible
   • Fixed-Income Markets and Issuance
     • Primary and secondary bond markets
     • Sovereign, corporate, and structured debt
     • Repurchase agreements and short-term funding
   • Introduction to Fixed-Income Valuation
     • Pricing bonds with spot rates
     • Yield measures and the yield curve
     • Matrix pricing and spreads over benchmarks
2. 2

   Yield Curves, Risk, and Credit

   4 topics

   • The Term Structure and Interest Rate Dynamics
     • Spot, forward, and par curves
     • Theories of the term structure
     • Arbitrage-free valuation and binomial trees
   • Understanding Fixed-Income Risk and Return
     • Macaulay, modified, and effective duration
     • Convexity and key rate duration
     • Money duration and interest rate risk
   • Credit Analysis
     • Credit ratings and the four Cs of credit
     • Credit spreads and structural/reduced-form models
     • Credit default swaps
   • Asset-Backed and Structured Securities
     • Mortgage-backed securities and prepayment risk
     • CMOs, CDOs, and tranching
     • Covered bonds
3. 3

   Derivatives

   3 topics

   • Derivative Markets and Instruments
     • Forwards, futures, swaps, and options
     • Exchange-traded vs. over-the-counter derivatives
     • Purposes and criticisms of derivatives
   • Pricing and Valuation of Forwards and Futures
     • Arbitrage and the law of one price
     • Carry arbitrage model and cost of carry
     • Futures vs. forward price differences
   • Pricing and Valuation of Swaps and Options
     • Interest rate, currency, and equity swaps
     • Binomial option pricing model
     • Black-Scholes-Merton and option Greeks
     • Put-call parity
4. 4

   Alternative Investments

   4 topics

   • Alternative Investment Features and Structures
     • Categories and characteristics of alternatives
     • Fee structures and the alignment of interests
     • Investment vehicles and due diligence
   • Private Capital and Real Assets
     • Private equity strategies (buyout, venture capital)
     • Private debt and direct lending
     • Real estate, infrastructure, and natural resources
   • Hedge Funds and Digital Assets
     • Hedge fund strategies and classification
     • Commodities and commodity derivatives
     • Digital assets and tokenization
   • Performance and Risk in Alternatives
     • Return measures: IRR, MOIC, and the J-curve
     • Risk and the role of leverage

Fixed Income, Derivatives, and Alternatives flashcards for Chartered Financial Analyst (CFA)

21 of 56 cards from the Fixed Income, Derivatives, and Alternatives deck — real questions with worked answers.

1. What is the difference between a bond's coupon rate and its required yield, and how does it determine whether the bond trades at a premium, par, or discount?

   The coupon rate is the fixed annual interest paid relative to face value; the required yield (market discount rate) is the return investors demand. If coupon rate > required yield, the bond trades at a premium; if coupon rate = required yield, at par; if coupon rate < required yield, at a discount.

2. Define the principal/par value, tenor, and coupon of a bond.

   Par value (face/redemption value) is the amount repaid at maturity. Tenor (term to maturity) is the time remaining until the principal is repaid. The coupon is the periodic interest payment, equal to the coupon rate times par value.

3. What is a bond indenture (trust deed), and what are affirmative versus negative covenants?

   The indenture is the legal contract between issuer and bondholders specifying the bond's terms. Affirmative (positive) covenants require the issuer to do certain things (e.g., maintain ratios, pay taxes). Negative covenants restrict the issuer's actions (e.g., limits on additional debt, asset sales, dividends).

4. Contrast a bullet bond, a fully amortizing bond, and a partially amortizing bond.

   A bullet bond pays only coupons and repays the entire principal at maturity. A fully amortizing bond repays principal gradually so the balance is zero at maturity (each payment includes interest plus principal). A partially amortizing bond amortizes some principal over its life and repays the remaining balloon balance at maturity.

5. How does a floating-rate note (FRN) coupon get determined, and what are the quoted margin and required margin?

   An FRN coupon = reference rate (e.g., a market reference rate, MRR) + quoted margin (a fixed spread set at issuance). The required margin (discount margin) is the spread investors currently demand; if it equals the quoted margin the FRN prices at par, if it exceeds the quoted margin the FRN trades at a discount.

6. Distinguish a callable bond, a putable bond, and a convertible bond from the bondholder's perspective.

   A callable bond gives the issuer the option to redeem early (disadvantages the holder, so it offers a higher yield). A putable bond gives the holder the option to sell back early (benefits the holder, so it offers a lower yield). A convertible bond gives the holder the option to convert into the issuer's common shares.

7. What is the conversion value and conversion price of a convertible bond?

   Conversion price is the par value divided by the conversion ratio (the number of shares received per bond). Conversion value = current share price $\times$ conversion ratio. The bond's minimum value is the greater of its conversion value and its straight (option-free) bond value.

8. In bond markets, how are issuers classified by sector?

   Major issuer categories are: supranational organizations (e.g., World Bank), sovereign (national) governments, non-sovereign/local governments, quasi-government (agency) entities, and corporate issuers (financial and non-financial). Bonds are also classified as investment grade versus high yield.

9. Differentiate between a primary market and a secondary market for bonds.

   The primary market is where issuers first sell new securities to raise capital (via underwritten offerings, best-efforts, auctions, or private placements). The secondary market is where existing securities trade among investors, providing liquidity and price discovery.

10. What is the difference between an underwritten offering and a best-efforts offering?

    In an underwritten offering, the investment bank buys the entire issue and resells it, bearing the risk of unsold bonds. In a best-efforts offering, the bank acts only as a broker/agent and sells what it can, bearing no underwriting risk.

11. How does a sovereign issuer typically sell bonds, and what is a 'when-issued' market?

    Sovereigns usually sell via auction (single-price/Dutch or multiple-price). The when-issued (gray) market is forward trading in a security after announcement but before its official issuance/settlement, allowing price discovery ahead of the auction.

12. State the general formula for the price of a fixed-rate bond as the present value of its cash flows.

    $$P = \sum_{t=1}^{N} \frac{PMT}{(1+r)^{t}} + \frac{FV}{(1+r)^{N}}$$ where $PMT$ is the periodic coupon, $FV$ the face value, $r$ the periodic market discount rate, and $N$ the number of periods.

13. What is the relationship between full price, flat price, and accrued interest?

    Full price (dirty price) = flat price (clean price) + accrued interest. Accrued interest $= \frac{t}{T} \times PMT$, where $t$ is days since the last coupon and $T$ is days in the coupon period. The flat price is the quoted price; the full price is what the buyer actually pays.

14. Define the yield to maturity (YTM) of a bond and list the assumptions required to actually earn it.

    YTM is the single internal rate of return that equates the present value of all the bond's cash flows to its price. To realize the YTM the investor must: hold the bond to maturity, the issuer makes all payments in full and on time, and all coupons are reinvested at the YTM.

15. What is a spot rate, and how is a bond priced using spot rates?

    A spot rate is the yield on a zero-coupon bond (discount rate for a single cash flow at one maturity). A bond is arbitrage-free priced by discounting each cash flow at its maturity-matched spot rate: $$P = \sum_{t=1}^{N} \frac{CF_{t}}{(1+z_{t})^{t}}$$ where $z_{t}$ is the spot rate for period $t$.

16. Define the current yield of a bond and contrast it with YTM.

    Current yield $= \frac{\text{Annual coupon payment}}{\text{Flat price}}$. Unlike YTM, it ignores any capital gain/loss to maturity, reinvestment of coupons, and the time value of money, so it is only a crude income measure.

17. What is the G-spread, the I-spread, and the Z-spread?

    G-spread is the yield spread over an actual government (benchmark) bond. I-spread is the spread over the swap rate. Z-spread (zero-volatility spread) is the constant spread added to every spot rate on the government curve that makes the present value of the bond's cash flows equal its price.

18. What is the option-adjusted spread (OAS), and how does it relate to the Z-spread for a callable bond?

    OAS is the Z-spread after removing the value of any embedded option, computed using an interest-rate model. For a callable bond, $\text{OAS} = \text{Z-spread} - \text{option cost}$; OAS allows comparison of bonds with and without embedded options on a like-for-like basis.

19. Define a forward rate and give the no-arbitrage relationship linking spot and forward rates.

    A forward rate is an interest rate agreed today for borrowing/lending starting at a future date. The no-arbitrage condition is $$(1+z_{B})^{B} = (1+z_{A})^{A}\,(1+f_{A,B-A})^{B-A}$$ so investing to time $B$ at the spot rate equals investing to $A$ then rolling forward.

20. What does the shape of the yield curve (term structure of interest rates) describe, and name three common shapes?

    The term structure shows yields (typically of default-free government bonds) plotted against maturity. Common shapes are upward-sloping (normal), flat, and downward-sloping (inverted); the curve can also be humped.

21. State and briefly explain the local expectations and pure (unbiased) expectations theories of the term structure.

    The unbiased (pure) expectations theory says forward rates are unbiased predictors of future spot rates, so long rates are the geometric average of expected short rates. The local expectations theory is a risk-neutral version asserting that, over a short horizon, all bonds have the same expected return equal to the risk-free rate.

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