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Free CFA Fixed Income Practice Questions & Answers
900 exam-style Fixed Income questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 1
A one-year spot rate is (3%) and the two-year spot rate is (4%). Which statement about the implied one-year forward rate starting in one year is most accurate?
Select an option first.
Correct answer: D — It must be higher than (3%).
Explanation: When the two-year spot rate is higher than the one-year spot rate, the implied one-year forward rate starting in one year will be above the one-year spot rate. That’s because the average return over two years (4%) is higher than the first-year rate (3%), so the second-year implied rate must be higher than 3% to “pull up” the average. A: Lower than 3% would pull the two-year average below 3%, which contradicts the 4% two-year spot rate. B: 3.5% is not guaranteed; the exact rate depends on compounding. C: It does not have to be higher than 4%; it just has to be high enough so that the two-year average is 4%.
Question 2
If the yield curve is flat and all spot rates are (4%), which statement is most accurate about forward rates?
Select an option first.
Correct answer: C — All forward rates are equal to 4%.
Explanation: With a perfectly flat spot curve, the average rate over any horizon is the same. That implies all forward rates equal the same constant rate. A/B: No reason for forward rates to be systematically above or below the flat spot rate. D: Forward rates are directly implied by spot rates; they are easily computed.
Question 3
Which of the following best describes the term premium on longer-maturity government bonds?
Select an option first.
Correct answer: C — The extra yield relative to rolling short-term bonds.
Explanation: The term premium is the expected excess return of a long-term bond over a strategy of rolling short-term bonds, compensating for interest rate and horizon risk. A: Default risk is usually minimal for high-quality sovereigns. B: Reinvestment risk is part of it, but not the full idea. D: That’s more about inflation risk, not the standard definition of term premium.
Question 4
Which yield curve movement is best described as bear flattening?
Select an option first.
Correct answer: C — Short-term yields rise more than long-term yields.
Explanation: “Bear” means yields rise (prices fall). “Flattening” means the difference between long and short yields narrows. That happens when short-term yields rise more than long-term yields. A: That’s bull steepening. B: That’s bear steepening. D: That’s a parallel shift, not flattening.
Question 5
The law of one price in fixed income implies that:
Select an option first.
Correct answer: B — Two portfolios with identical cash flows must have the same price.
Explanation: If two portfolios generate the same cash flows in all states and at all times, they must have the same price; otherwise, arbitrage is possible. A: Coupons can differ if prices differ accordingly. C: Bonds rarely all trade at par. D: Yields differ based on risk, coupons, and prices.
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Question 6
A one-year spot rate is (3%) and the two-year spot rate is (4%). Which statement about the implied one-year forward rate starting in one year is most accurate?
Select an option first.
Correct answer: D — It must be higher than (3%).
Explanation: When the two-year spot rate is higher than the one-year spot rate, the implied one-year forward rate starting in one year will be above the one-year spot rate. That’s because the average return over two years (4%) is higher than the first-year rate (3%), so the second-year implied rate must be higher than 3% to “pull up” the average. A: Lower than 3% would pull the two-year average below 3%, which contradicts the 4% two-year spot rate. B: 3.5% is not guaranteed; the exact rate depends on compounding. C: It does not have to be higher than 4%; it just has to be high enough so that the two-year average is 4%.
Question 7
If the yield curve is flat and all spot rates are (4%), which statement is most accurate about forward rates?
Select an option first.
Correct answer: C — All forward rates are equal to 4%.
Explanation: With a perfectly flat spot curve, the average rate over any horizon is the same. That implies all forward rates equal the same constant rate. A/B: No reason for forward rates to be systematically above or below the flat spot rate. D: Forward rates are directly implied by spot rates; they are easily computed.
Question 8
Which of the following best describes the term premium on longer-maturity government bonds?
Select an option first.
Correct answer: C — The extra yield relative to rolling short-term bonds.
Explanation: The term premium is the expected excess return of a long-term bond over a strategy of rolling short-term bonds, compensating for interest rate and horizon risk. A: Default risk is usually minimal for high-quality sovereigns. B: Reinvestment risk is part of it, but not the full idea. D: That’s more about inflation risk, not the standard definition of term premium.
Question 9
Which yield curve movement is best described as bear flattening?
Select an option first.
Correct answer: C — Short-term yields rise more than long-term yields.
Explanation: “Bear” means yields rise (prices fall). “Flattening” means the difference between long and short yields narrows. That happens when short-term yields rise more than long-term yields. A: That’s bull steepening. B: That’s bear steepening. D: That’s a parallel shift, not flattening.
Question 10
The law of one price in fixed income implies that:
Select an option first.
Correct answer: B — Two portfolios with identical cash flows must have the same price.
Explanation: If two portfolios generate the same cash flows in all states and at all times, they must have the same price; otherwise, arbitrage is possible. A: Coupons can differ if prices differ accordingly. C: Bonds rarely all trade at par. D: Yields differ based on risk, coupons, and prices.
Question 11
In a binomial interest rate tree calibrated to the current yield curve, the main purpose of calibration is to:
Select an option first.
Correct answer: B — Match model bond prices to current market prices.
Explanation: Calibration adjusts the tree so that discounting cash flows along the tree reproduces current market prices of benchmark instruments. A: The model can handle many shapes. C: Volatility is essential for option valuation. D: Forward rates guide the tree, but calibration is about matching prices, not forcing exact equality at every node.
Question 12
Which statement best describes a no-arbitrage term structure model?
Select an option first.
Correct answer: B — It is calibrated so that model prices match current market prices.
Explanation: No-arbitrage models are built so that discounting with model rates reproduces current market prices, ensuring no arbitrage relative to observed prices. A: Mean reversion is a feature of some equilibrium models, not a requirement. C: They explicitly use the current curve. D: Drift assumptions vary by model.
Question 13
When the stock price is far below the conversion price, a convertible bond tends to behave like:
Select an option first.
Correct answer: C — A straight bond.
Explanation: The conversion option is deep out-of-the-money, so the bond’s value is dominated by its bond-like features. A: Equity-like behavior appears when the option is in-the-money. B: That’s when the stock price is near the conversion price. D: Credit risk still exists; it’s not risk-free.
Question 14
A credit spread on a corporate bond is:
Select an option first.
Correct answer: A — The difference between its yield and the risk-free or benchmark yield.
Explanation: Credit spread = yield on risky bond − yield on benchmark (e.g., government or swap). B: That’s coupon–yield, not a spread to benchmark. C: That’s price discount/premium. D: That’s a real yield concept.
Question 15
A plain-vanilla, option-free bond is most accurately described as having which of the following cash flow patterns?
Select an option first.
Correct answer: B — Fixed coupons, fixed principal repayment at maturity
Explanation: An option-free, plain-vanilla bond pays fixed coupons at regular intervals and repays the full principal at maturity.
Question 16
The clean price of a bond is best described as:
Select an option first.
Correct answer: B — The quoted price excluding accrued interest
Explanation: Clean price is the quoted bond price excluding accrued interest; full (dirty) price equals clean price plus accrued interest.
Question 17
All else equal, which bond is most sensitive to changes in interest rates?
Select an option first.
Correct answer: D — 15-year, 2% coupon bond
Explanation: Interest rate sensitivity increases with longer maturity and lower coupon; the 15-year, 2% coupon bond has the highest duration.
Question 18
A bond has a yield to maturity (YTM) of 5% and a current yield of 4%. Which of the following is most likely true?
Select an option first.
Correct answer: B — The bond is selling at a discount
Explanation: For coupon bonds, if YTM > current yield, the bond trades at a discount; if YTM < current yield, it trades at a premium.
Question 19
The spot rate for a given maturity is best described as:
Select an option first.
Correct answer: B — The yield on a zero-coupon bond for that maturity
Explanation: Spot rates are yields on default-free zero-coupon bonds for specific maturities, used to discount single cash flows.
Question 20
Which of the following is a key assumption of the pure expectations theory of the term structure?
Select an option first.
Correct answer: C — Long-term rates are geometric averages of current and expected future short-term rates
Explanation: Pure expectations theory states that long-term spot rates reflect the compounded expected future short-term rates, with no term premium.
Question 21
A 5-year annual-pay bond has a 6% coupon and is priced to yield 5%. Which of the following is most accurate?
Select an option first.
Correct answer: C — The bond sells at a premium and has both price and reinvestment risk
Explanation: Coupon > YTM implies a premium bond. All coupon bonds have both price risk (if sold before maturity) and reinvestment risk.
Question 22
A credit spread is best defined as:
Select an option first.
Correct answer: B — The difference between the yield of a risky bond and a risk-free benchmark
Explanation: Credit spread is the yield premium investors demand for bearing credit risk relative to a default-free benchmark of similar maturity.
Question 23
A covenant in a bond indenture is best described as:
Select an option first.
Correct answer: B — A contractual provision that restricts or requires certain issuer actions
Explanation: Covenants are legally binding provisions in the bond indenture that protect bondholders by limiting issuer behavior or requiring specific actions.
Question 24
In a floating-rate note (FRN), the reference rate is 3-month LIBOR plus a spread of 150 bps. If current 3-month LIBOR is 2.0%, the next coupon rate is:
Select an option first.
Correct answer: C — 3.5%
Explanation: Coupon rate on an FRN equals reference rate plus quoted margin: (2.0% + 1.5% = 3.5%).
Question 25
The quoted margin on a floating-rate note is 120 bps, but the required margin given the issuer’s risk is 150 bps. The FRN is most likely trading at:
Select an option first.
Correct answer: C — A discount
Explanation: If the quoted margin is less than the required margin, the coupon is insufficient for the risk, so the FRN trades at a discount.
Question 26
Yield to maturity is best described as:
Select an option first.
Correct answer: A — The internal rate of return assuming the bond is held to maturity and coupons are reinvested at the YTM
Explanation: YTM is the IRR that equates the present value of all promised cash flows to the bond’s current price, assuming reinvestment at that rate and no default.
Question 27
The Z-spread for a bond is:
Select an option first.
Correct answer: A — The spread over the benchmark yield curve that equates the present value of cash flows to price
Explanation: Z-spread (zero-volatility spread) is the constant spread added to each point on the benchmark spot curve to discount the bond’s cash flows to its market price, ignoring embedded options.
Question 28
Reinvestment risk is most significant for which type of bond?
Select an option first.
Correct answer: B — High-coupon, short-maturity bond
Explanation: High coupons and shorter maturities generate larger interim cash flows that must be reinvested; uncertainty about reinvestment rates increases reinvestment risk.
Question 29
Under the liquidity preference theory of the term structure, an upward-sloping yield curve most likely reflects:
Select an option first.
Correct answer: C — Both expectations of future short-term rates and a positive term premium
Explanation: Liquidity preference theory states that long-term rates equal expected future short-term rates plus a positive term premium for holding less liquid, longer-term bonds.
Question 30
A bond’s yield to worst is best described as the:
Select an option first.
Correct answer: B — Lowest yield among all possible call, put, or maturity dates
Explanation: Yield to worst is the minimum yield across all embedded-option exercise dates and maturity.
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