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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 601
According to the liquidity preference theory of the term structure, long-term bond yields include a 'term premium' because:
Select an option first.
Correct answer: B — Investors demand extra compensation for the greater price risk and lower liquidity of longer-term bonds
Explanation: B is correct. The liquidity preference theory holds that investors prefer shorter maturities and must be paid a positive term premium to hold longer bonds. This premium rises with maturity. A, C, D are incorrect.
Question 602
A forward rate is best described as:
Select an option first.
Correct answer: B — The interest rate agreed upon today for a loan starting at a future date, derived from today's spot rates
Explanation: B is correct. Forward rates are extracted from today's spot rate curve—they represent the implied rate for a future period. For example, the 1-year rate 2 years from now (written 2f1) is calculated from 2-year and 3-year spot rates. A is a future issuance yield, not a forward rate. C is the policy rate.
Question 603
The relationship between a par rate and the spot rate curve is:
Select an option first.
Correct answer: B — The par rate is the coupon rate that makes a bond price exactly at par given the spot rate curve
Explanation: B is correct. The par rate for a given maturity is the coupon rate that, when used to value a bond via the spot rate curve, produces a price exactly equal to par. When the yield curve is upward-sloping, par rates are below spot rates of the same maturity.
Question 604
A bond's yield to call (YTC) will be relevant to an investor when:
Select an option first.
Correct answer: B — The bond is callable and the investor wants to know the return if the issuer calls at the earliest possible call date
Explanation: B is correct. YTC computes the return assuming the issuer exercises the call option on the first call date. Investors in callable bonds must consider YTC alongside YTM because the issuer will likely call if rates fall—potentially capping the investor's return. A is put bonds. C and D are unrelated.
Question 605
The relationship between bond price and yield is convex rather than linear, meaning:
Select an option first.
Correct answer: C — For a given change in yield, price rises more when yields fall than it falls when yields rise by the same amount
Explanation: C is correct. Convexity means the price-yield curve bows outward (toward the origin). For a given yield decrease, the price rises by more than it falls for an equal yield increase. This asymmetry is favorable and is why convexity is a desirable bond characteristic. D is wrong—duration is a linear approximation.
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Question 606
When interest rates are highly volatile, which bond feature adds more value to investors?
Select an option first.
Correct answer: B — Greater positive convexity
Explanation: B is correct. Greater convexity means the bond outperforms a duration-matched bond when yields move significantly in either direction. Higher volatility amplifies this benefit. A affects current yield not the volatility benefit. C increases duration but not necessarily convexity.
Question 607
A yield spread between two bonds narrows from 100 bps to 60 bps. This most likely means:
Select an option first.
Correct answer: B — The market perceives the higher-yielding bond as less risky relative to the benchmark, pushing its price up
Explanation: B is correct. Spread narrowing means the risky bond's yield fell closer to the benchmark—reflecting improved perception of credit quality or increased demand. This is associated with a price increase for the higher-yielding bond. A would widen spreads. C and D don't directly explain spread narrowing.
Question 608
The I-spread is calculated by comparing a bond's yield to:
Select an option first.
Correct answer: B — The interpolated swap rate of the same maturity
Explanation: B is correct. The I-spread is the bond's yield minus the (interpolated) par swap rate of the same maturity. Swap rates are used as a benchmark because they reflect interbank credit risk and are highly liquid. A is the G-spread. C is the Z-spread.
Question 609
Which of the following most accurately describes the difference between nominal and real yields?
Select an option first.
Correct answer: B — Real yield adjusts for inflation; nominal yield does not
Explanation: B is correct. The nominal yield includes expected inflation; the real yield is the inflation-adjusted return. This is captured in the Fisher relationship: nominal rate ≈ real rate + expected inflation. A, C, D are incorrect descriptions.
Question 610
Bond equivalent yield (BEY) is a convention that:
Select an option first.
Correct answer: A — Doubles the semiannual yield to express it as an annual rate
Explanation: A is correct. BEY is a US convention: take the semiannual YTM, multiply by 2 to get an annual (not compounded) rate. It allows comparison of semiannual-pay bonds on an annual basis. B, C, D are incorrect.
Question 611
The 'flat price' of a bond in a market quotation excludes accrued interest because:
Select an option first.
Correct answer: B — Stripping out accrued interest makes price comparisons across bonds cleaner, since accrued interest varies with settlement date
Explanation: B is correct. Quoting a flat (clean) price removes the mechanical daily accumulation of accrued interest, making it easier to compare bond prices over time and across bonds. The buyer pays the full (dirty) price, which includes accrued interest. A, C, D are incorrect.
Question 612
For a bond with no embedded options, a fall in market interest rates will most likely cause:
Select an option first.
Correct answer: B — The bond price to rise and YTM to fall
Explanation: B is correct. Bond prices and yields move inversely. When market rates (and thus required yields) fall, the fixed cash flows are discounted at lower rates—their PV rises, so price rises. YTM adjusts down to match the new higher price. A is the reverse. C is wrong—they move in opposite directions.
Question 613
The term 'discount margin' (DM) for a floating-rate note represents:
Select an option first.
Correct answer: B — The constant spread over the reference rate that equates the PV of the FRN's cash flows to its current price
Explanation: B is correct. The discount margin (DM) is the spread over the current reference rate that, when used to discount the FRN's projected cash flows, gives the FRN's current market price. It is analogous to YTM for a fixed-rate bond. A is price discount. C and D are incorrect.
Question 614
All else equal, which bond will have the longest Macaulay duration?
Select an option first.
Correct answer: B — A 10-year zero-coupon bond
Explanation: B is correct. A zero-coupon bond's Macaulay duration equals its maturity. A 10-year zero has duration = 10. Coupon bonds of the same maturity have shorter durations because early coupon payments pull the weighted-average timing forward. D is a 5-year zero with duration 5.
Question 615
Which yield measure is most appropriate to use when comparing bonds with different coupon payment frequencies?
Select an option first.
Correct answer: C — The effective annual yield (EAY), which accounts for compounding
Explanation: C is correct. The effective annual yield (EAY) standardizes for compounding frequency—(1 + periodic rate)^m − 1—making bonds with different payment frequencies directly comparable. BEY is a nominal rate that doesn't account for compounding. Current yield ignores capital gains.
Question 616
The 'constant-yield price trajectory' of a bond over its life shows that:
Select an option first.
Correct answer: B — If yield remains constant, a premium bond's price declines toward par and a discount bond's price rises toward par
Explanation: B is correct. The constant-yield price trajectory maps the bond's price over time assuming YTM doesn't change. A premium bond starts above par and gradually amortizes down to par. A discount bond starts below par and accretes up to par. This is the 'pull to par' effect.
Question 617
An upward-sloping par yield curve implies that the corresponding spot rate curve is:
Select an option first.
Correct answer: B — Also upward-sloping and lies above the par yield curve at each maturity
Explanation: B is correct. When the par curve is upward-sloping, spot rates exceed par rates at the same maturity. This is because par rates are an average over time—weighted by coupons—while longer spot rates fully capture the higher long-run rates.
Question 618
For a floating-rate note, interest rate risk is lower than for a fixed-rate bond of the same maturity because:
Select an option first.
Correct answer: B — The coupon resets periodically to market rates, reducing price sensitivity to interest rate changes
Explanation: B is correct. Because the coupon resets to current market rates at each reset date, the FRN's price stays close to par after each reset—reducing its duration to approximately the time until the next reset. Fixed-rate bonds' prices are sensitive to the full maturity's worth of rate moves.
Question 619
The local expectations theory of the term structure implies that:
Select an option first.
Correct answer: A — All bonds earn the same expected return only over short holding periods
Explanation: A is correct. The local expectations theory states that all bonds offer the same expected return over a very short period (locally), not necessarily over long horizons. This is used to justify risk-neutral pricing in bond models.
Question 620
The market segmentation theory of the yield curve suggests that:
Select an option first.
Correct answer: B — The yield curve shape is determined independently in each maturity segment by supply and demand within that segment
Explanation: B is correct. Market segmentation theory holds that different investors and issuers have distinct maturity preferences. Yields in each segment are driven by supply/demand within that segment, not arbitrage across maturities. A describes the pure expectations theory. C is unbiased expectations. D is liquidity preference.
Question 621
A 'riding the yield curve' strategy profits from:
Select an option first.
Correct answer: B — Buying bonds with maturities longer than the investment horizon, then selling them as their maturity shortens and they roll down a steep yield curve
Explanation: B is correct. In a steep, stable yield curve environment, a bond's yield falls as it ages (rolls down the curve), causing price appreciation beyond the coupon income. The investor sells before maturity to capture this. A is a losing strategy. C is not riding the curve. D is a credit strategy.
Question 622
Which of the following is the most direct use of the spot rate curve?
Select an option first.
Correct answer: B — To price coupon bonds by discounting each cash flow at the maturity-matched spot rate
Explanation: B is correct. Spot rates represent zero-coupon yields for each maturity. When pricing a coupon bond, each coupon and the par payment are discounted at their respective spot rates—giving an arbitrage-free price.
Question 623
Inflation expectations affect bond yields primarily because:
Select an option first.
Correct answer: B — Investors demand higher nominal yields to maintain a targeted real return as expected inflation rises
Explanation: B is correct. If investors expect more inflation, they require a higher nominal yield to achieve the same real return. This pushes bond prices down. A is wrong—coupon rates are fixed. C and D are indirect or unrelated effects.
Question 624
The 'price value of a basis point' (PVBP) measures:
Select an option first.
Correct answer: B — The dollar change in a bond's price for a 1 basis point change in yield
Explanation: B is correct. PVBP (also called DV01) is the monetary sensitivity of a bond to a 1 bp yield move. It equals Modified Duration × Price × 0.0001. It is used to hedge bond positions. A is wrong—PVBP is not a coupon adjustment. C is annual income/par = coupon rate.
Question 625
A bond's coupon rate relative to its YTM determines whether the bond prices at par, premium, or discount. Which pairing is correct?
Select an option first.
Correct answer: C — Coupon rate = YTM → bond trades at par
Explanation: C is correct. When the coupon rate exactly equals the YTM (required yield), the present value of all cash flows equals par—the bond prices at par. If coupon > YTM, the bond prices at a premium. If coupon < YTM, it prices at a discount.
Question 626
When a bond's YTM is stated on a semiannual basis, converting it to an annual effective rate requires:
Select an option first.
Correct answer: C — Squaring one plus the semiannual periodic rate and subtracting one: (1 + r/2)² − 1
Explanation: C is correct. To convert a semiannual yield to a true annual effective yield, compound it: (1 + semiannual rate)² − 1. Multiplying by 2 (B) gives the BEY, which is a nominal annual rate. A and D are wrong.
Question 627
A bond's yield to worst (YTW) is most relevant for callable bonds because:
Select an option first.
Correct answer: B — It finds the lowest yield among all possible call scenarios and the yield to maturity, indicating the worst case for the bondholder
Explanation: B is correct. Yield to worst (YTW) identifies the most unfavorable yield scenario for the holder—if the issuer calls early at the worst time, what is the lowest return the bondholder could receive? It is always ≤ YTM.
Question 628
A bond's accrued interest calculation typically depends on:
Select an option first.
Correct answer: B — The day-count convention (e.g., 30/360 or actual/actual), the coupon rate, and the number of days since the last coupon
Explanation: B is correct. Accrued interest = Semiannual (or periodic) coupon × (days elapsed since last coupon / days in coupon period). The day-count convention determines how days are counted. A ignores days elapsed. C and D are not inputs to accrued interest.
Question 629
A bond's full price equals its clean price plus accrued interest. As accrued interest builds toward the next coupon date, the clean price will:
Select an option first.
Correct answer: B — Remain roughly stable (moving with yield changes), while the full price rises steadily
Explanation: B is correct. The clean (flat) price moves primarily with changes in required yield—it doesn't mechanically rise with each passing day. The full price = clean + accrued, and accrued increases daily until the coupon is paid, then resets to zero. A is wrong. C reverses the direction. D is only partially correct.
Question 630
In a normal (upward-sloping) yield curve, a bond investor can generate an additional return by 'rolling down the curve.' This works because:
Select an option first.
Correct answer: B — As time passes, the bond's remaining maturity shortens and it is priced at a lower yield, generating a capital gain
Explanation: B is correct. Rolling down the curve: a bond bought at a higher maturity point (higher yield) gains value as it ages into a lower-yield maturity on the curve—assuming the curve shape is stable. The declining yield as the bond ages translates into price appreciation beyond coupon income.
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