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51 multiple-choice questions and 32 flashcards on Fixed Income, about 13% of the CFA Level II bank. Every one carries a written rationale.
Fixed Income is one of 10 chapters in CoStudy's CFA Level II bank, and it holds 51 of the bank's 401 multiple-choice questions — roughly 13% of the total. That proportion is not arbitrary: chapters follow the certifying body's published exam outline, and the number of questions in each is set by that domain's published weight, so the share of your practice time this chapter takes matches the share of the real exam it accounts for.
Studying by chapter is worth doing once you have a diagnostic score. A single overall percentage tells you whether you are close; it does not tell you which domain is dragging. Working a weak chapter in isolation, and re-testing it in isolation, is the fastest way to move a score that has stalled — and it is why the mock exams in CoStudy report by domain rather than as one number.
10 questions drawn from this chapter, with the full rationale shown — the controlling principle behind the right answer, and why each wrong option tempts and fails.
A two-tranche structure issues $80M senior at 5% and $20M equity. Pool returns 7% on $100M assets. The equity tranche's return after distributing senior interest is:
Answer: D — (7 − 0.8 × 5) / 0.2 = 15%
A) CDS index tranche exposure — related concept, not the definition. B) Putable bond value formula — related concept, not the definition. C) CDS protection buyer payoff — related concept, not the definition. D) Correct — this identifies (7 − 0.8 × 5) / 0.2 = 15%.
Direct lending (private credit) funds typically generate returns that are MOST sensitive to:
Answer: B — Credit spreads in this context
A) AFFO net of maintenance capex — related concept, not the definition. B) Correct — this identifies Credit spreads in this context. C) IRR dollar-weighted PE return — related concept, not the definition. D) Roll yield in contango negative — wrong roll-yield direction.
A subordinated tranche in a CMO structure experiences contraction risk MOST when:
Answer: A — Interest rates fall in this context
A) Correct — this identifies Interest rates fall in this context. B) Pure expectations of forward rates — related concept, not the definition. C) Modified duration linear estimate — look-alike duration measure. D) Macaulay duration weighted years — look-alike duration measure.
In a binomial interest-rate tree calibrated to the benchmark yield curve, a callable bond is properly valued at each node as the LESSER of (i) the call price and (ii) the present value of the node's expected future cash flows. An analyst instead values the bond at each node as the GREATER of the two values. This error will cause the model to:
Answer: C — Overstate the callable bond's value by ignoring the issuer's incentive to call when the bond is worth more than the call price
A) Gets the direction backwards — using the greater value at each node inflates, rather than understates, the resulting price. B) Incorrect — the call feature is exercisable at multiple nodes throughout the tree (an American-style feature), not only at maturity. C) Correct — capping value at the call price reflects that the issuer will call the bond whenever its value exceeds the call price; using the greater value instead ignores this issuer incentive and prices the bond as if it were non-callable (or putable), overstating its value. D) Misattributes the exercise decision — it is the issuer, not the bondholder, who decides whether to call the bond, so the bondholder's preference is not the relevant constraint at each node.
A bond has key-rate durations of 0.9 (2-yr), 2.1 (5-yr), 3.4 (10-yr), and 1.6 (30-yr), with all other key-rate durations equal to zero. For a parallel 50 bp increase across the entire benchmark curve, the approximate percentage price change is CLOSEST to:
Answer: B — −4.00%
A) Uses only the largest single key-rate duration (the 10-year point) as if it represented the bond's total interest-rate sensitivity. B) Correct — for a parallel shift, the sum of key-rate durations equals the bond's effective duration: 0.9+2.1+3.4+1.6 = 8.0; ΔP/P ≈ −8.0 × 0.50% = −4.00%. C) Averages the four key-rate durations (8.0/4 = 2.0) instead of summing them, understating total interest-rate sensitivity. D) Applies the 50 bp shift twice, as though a separate 'level' effect and 'curve' effect both applied to a purely parallel move, double-counting the sensitivity.
At a given node in a binomial interest-rate tree, the present value of a callable bond's expected future cash flows (discounted from the two successor nodes) is $101.80. The bond's call price at that node is $100.50. Under the standard backward-induction rule for valuing a callable bond, the value assigned to this node is CLOSEST to:
Answer: C — $100.50
A) Uses the greater of the two values, ignoring the issuer's incentive to call the bond once its value exceeds the call price. B) Averages the call price and the PV of expected cash flows instead of applying the minimum rule that backward-induction requires. C) Correct — the callable bond is valued at each node as the lesser of the call price and the PV of expected future cash flows: min($101.80, $100.50) = $100.50. D) Over-adjusts by subtracting the difference between the two values a second time from the call price, effectively double-counting the option's cost.
An investor seeking to immunize a $100M liability due in 6 years should construct a bond portfolio with:
Answer: C — Macaulay duration equal to 6 years, with convexity that matches or slightly exceeds the liability's convexity
A) Pure expectations theory concerns forward rate expectations, not the construction of an immunizing portfolio. B) Modified duration is a linear approximation used for smaller yield changes; the immunization condition is stated in terms of Macaulay duration. C) Correct — classical immunization requires the portfolio's Macaulay duration to equal the liability's horizon, with matching (or slightly greater) convexity to limit reinvestment/price risk mismatch. D) The nominal spread is a credit-risk measure, unrelated to the duration-matching condition for immunization.
A callable bond exhibits 'negative convexity' at low yields because the call option:
Answer: A — Caps the bond's price near the call
A) Correct — this identifies Caps the bond's price near the call price. B) Pure expectations of forward rates — related concept, not the definition. C) Modified duration linear estimate — look-alike duration measure. D) Macaulay duration weighted years — look-alike duration measure.
A 10-year option-free bond has modified duration 8.2 and convexity 95. If yields rise 100 bps, the approximate percentage price change is:
Answer: D — −8.20% + 0.475% = −7.73% per calc
A) −9.02% per calc approx (rounded) — off-by-percent numeric trap. B) −7.38% per calc approx (rounded) — off-by-percent numeric trap. C) −9.84% per calc approx (rounded) — off-by-percent numeric trap. D) Correct — the computed value is −8.20% + 0.475% = −7.73%.
A bond portfolio has key-rate durations of 2.0 at the 2-year point, 4.5 at the 5-year point, and 6.0 at the 10-year point (all other key-rate durations are zero). The 2-year rate falls 25 bp, the 5-year rate is unchanged, and the 10-year rate rises 25 bp (a steepening twist). The approximate percentage change in portfolio value is CLOSEST to:
Answer: D — −1.00%
A) Incorrectly treats the offsetting rate moves at different maturities as netting to zero, as though a single effective duration and an averaged yield change applied instead of point-by-point key-rate durations. B) Gets the correct magnitude but omits the negative sign in the ΔP/P ≈ −KRD×Δy relationship. C) Ignores the offsetting 2-year rate decline and applies only the 10-year key-rate duration to the 10-year move. D) Correct — ΔP/P ≈ −(2.0×(−0.0025)) − (4.5×0) − (6.0×0.0025) = 0.0050 − 0 − 0.0150 = −1.00%.
2 cards from the 32 in this chapter.
What is sovereign debt and its key risk metrics?
Debt issued by a national government. Risks measured by debt-to-GDP, fiscal balance, current account, FX reserves, political stability, ratings.
In a vignette: junk bond default spread widens 200 bp. Effect on prices?
Prices fall significantly (high duration × spread move). Bondholders may face large MTM losses; recovery rates assumed in calculations.
These are a sample. The full Fixed Income chapter runs 83 items with per-chapter progress tracking, on the web and in the iOS app.
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