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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 781
The reinvestment risk in bond investing refers to:
Select an option first.
Correct answer: B — The uncertainty that coupon cash flows received during the bond's life will be reinvested at a lower rate than the original YTM
Explanation: B is correct. YTM assumes reinvestment of all coupons at the same YTM rate. If actual reinvestment rates are lower (e.g., rates have fallen), the investor's realized return will be less than the original YTM. C is default risk. D is call risk.
Question 782
A 'cash flow CDO' differs from a 'market value CDO' primarily in that:
Select an option first.
Correct answer: B — In a cash flow CDO, interest and principal payments to tranches come from the collateral's contractual cash flows; in a market value CDO, payments depend on trading gains
Explanation: B is correct. Cash flow CDOs rely on the natural interest and principal cash flows of the underlying loans or bonds. Market value CDOs are actively managed—the manager trades the portfolio and distributes gains, adding mark-to-market risk.
Question 783
Overcollateralization (OC) in an ABS structure means:
Select an option first.
Correct answer: B — The face value of the collateral pool exceeds the face value of the securities issued, providing a buffer against losses
Explanation: B is correct. Overcollateralization is a credit enhancement: if a $110 pool backs $100 of notes, the extra $10 absorbs losses before any tranche is affected. It is a common form of structural protection in ABS.
Question 784
A 'sequential-pay CMO' differs from a pass-through MBS in that:
Select an option first.
Correct answer: B — Principal payments are directed entirely to the first tranche until it is retired, then to the second, etc., concentrating short-maturity exposure in early tranches
Explanation: B is correct. In a sequential-pay CMO, cash flows from the mortgage pool are directed to retire Tranche A completely first, then Tranche B, etc. This creates shorter and longer maturity securities from the same pool, allowing investors to target their preferred maturity range.
Question 785
The concept of 'bankruptcy remoteness' in securitization means:
Select an option first.
Correct answer: A — The SPV's assets cannot be accessed by the originator's creditors if the originator goes bankrupt
Explanation: A is correct. Bankruptcy remoteness is achieved by structuring the SPV so that it is legally separate from the originator. If the originator files for bankruptcy, creditors cannot reach the SPV's assets—protecting ABS investors. B, C, D are incorrect.
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Question 786
The primary reason that long-duration bonds have greater interest rate risk than short-duration bonds is:
Select an option first.
Correct answer: B — Their cash flows are received further in the future and are therefore more sensitive to changes in the discount rate
Explanation: B is correct. Duration measures the weighted-average time to receipt of cash flows. Cash flows received further in the future have greater PV sensitivity to rate changes—just as a longer time period amplifies compounding effects. A, C, D are unrelated to duration's interest rate risk role.
Question 787
Which of the following best describes the role of a servicer in a mortgage-backed security?
Select an option first.
Correct answer: B — To collect monthly payments from borrowers and distribute them to the MBS investors after retaining a fee
Explanation: B is correct. The servicer collects principal and interest from homeowners, handles delinquencies, and remits the cash flows (net of servicing fee) to the MBS trustee for distribution to investors. The servicer doesn't originate new loans or guarantee credit.
Question 788
Which type of interest rate risk describes the possibility that the yield curve will shift by different amounts at different maturities?
Select an option first.
Correct answer: B — Curve risk (non-parallel shift risk)
Explanation: B is correct. Non-parallel (curve) risk arises when different parts of the yield curve move by different amounts—a twist or flattening/steepening. Parallel shift risk (A) is when all rates move by the same amount. C and D are different risk types.
Question 789
A 'covered bond' provides investors with dual recourse because:
Select an option first.
Correct answer: B — The investor can claim against both the collateral pool (on the issuer's balance sheet) and the issuer itself if the pool is insufficient
Explanation: B is correct. In covered bonds, the cover pool (collateral) stays on the issuer's balance sheet. Investors have a preferential claim on the pool AND a general claim against the issuer—hence dual recourse. This contrasts with ABS where investors only have recourse to the SPV's assets.
Question 790
Which of the following statements about Macaulay duration is most accurate?
Select an option first.
Correct answer: B — For a coupon bond, Macaulay duration is always less than or equal to its time to maturity
Explanation: B is correct. For a coupon bond, Macaulay duration < maturity because early coupon payments pull the weighted average forward. For a zero-coupon bond, Macaulay duration = maturity exactly (only one payment at maturity). A is wrong—zero-coupon has duration = maturity.
Question 791
A sovereign's external debt is considered riskier than its local-currency debt primarily because:
Select an option first.
Correct answer: B — The government cannot create foreign currency to service external debt, unlike local currency debt
Explanation: B is correct. A government can print its own currency (albeit with inflation risk) to service local-currency debt. It cannot print a foreign currency, so external (foreign-currency) debt creates a genuine default risk if reserves or export earnings are insufficient.
Question 792
The PSA prepayment model expresses mortgage prepayment speed as:
Select an option first.
Correct answer: B — A percentage of the standard 'benchmark' prepayment curve (100% PSA means following the standard schedule)
Explanation: B is correct. The PSA model benchmarks prepayment speed against a standard curve: 0.2% CPR/month rising for 30 months, then flat at 6% CPR. 100% PSA follows this exactly; 200% PSA doubles the prepayment speed at each point. A, C, D are incorrect descriptions.
Question 793
In the context of fixed income risk, 'key rate duration' is most useful for:
Select an option first.
Correct answer: B — Identifying which specific maturities on the yield curve most affect a bond or portfolio's value
Explanation: B is correct. Key rate duration breaks down overall duration into sensitivities at specific maturities (e.g., 2-year, 5-year, 10-year key rates). This reveals the portfolio's exposure to non-parallel yield curve moves—a 'twist' or 'butterfly' shift affects different key rates differently.
Question 794
A portfolio manager is said to be 'long duration' relative to a benchmark if:
Select an option first.
Correct answer: B — The portfolio's modified duration exceeds the benchmark's duration, meaning the portfolio is more sensitive to rate movements
Explanation: B is correct. Being long duration means the portfolio has greater interest rate sensitivity than its benchmark. If rates fall, a long-duration portfolio outperforms; if rates rise, it underperforms. A is about position size, not duration. C is about yield, not duration. D is imprecise.
Question 795
A bond has modified duration 7 and price $1,000. If yield rises by 60 bps, what is the approximate dollar price change?
Select an option first.
Correct answer: A — −$42.00
Explanation: A is correct. ΔP ≈ −ModDur × Price × Δy = −7 × $1,000 × 0.006 = −$42.00. B multiplies by 10 (uses 6%). C divides by 10. D uses 1% change.
Question 796
A 5-year bond has a modified duration of 4.2. If the yield falls by 75 bps, what is the approximate percentage price change?
Select an option first.
Correct answer: A — +3.15%
Explanation: A is correct. %ΔP ≈ −ModDur × Δy = −4.2 × (−0.0075) = +0.0315 = +3.15%. When yields fall, prices rise — positive sign. B has wrong sign. C uses 1% change. D uses 50 bps.
Question 797
A CDS has a notional of $10,000,000 and a recovery rate of 40%. If a credit event occurs, what is the CDS protection payment?
Select an option first.
Correct answer: B — $6,000,000
Explanation: B is correct. CDS protection payment = Notional × (1 − Recovery rate) = $10,000,000 × (1 − 0.40) = $6,000,000. A is the recovery amount. C is full notional (applies only if recovery = 0%). D is too low.
Question 798
A bond has modified duration 6 and convexity 45. A 1% yield increase leads to a price change of approximately:
Select an option first.
Correct answer: A — −5.775%
Explanation: A is correct. %ΔP = −6 × 0.01 + 0.5 × 45 × (0.01)^2 = −0.06 + 0.5 × 45 × 0.0001 = −0.06 + 0.00225 = −0.05775 = −5.775%. B ignores convexity. C adds rather than subtracts convexity correction.
Question 799
A bond with $1,000 par, 8% annual coupon, defaults. The recovery rate is 45%. What is the loss given default per $1,000 face value?
Select an option first.
Correct answer: A — $550
Explanation: A is correct. LGD = (1 − Recovery rate) × Face value = (1 − 0.45) × $1,000 = 0.55 × $1,000 = $550. The recovery amount is $450 (= 35% × $1,000 → wait, 45% × $1,000 = $450). B is the recovery amount. C is the full face. D is the price discount.
Question 800
A credit analyst estimates PD = 2.5% per year, Recovery rate = 40%. What is the expected loss on a $10,000,000 bond over one year?
Select an option first.
Correct answer: A — $150,000
Explanation: A is correct. Expected loss = PD × LGD × Notional = 2.5% × (1 − 40%) × $10,000,000 = 0.025 × 0.60 × $10,000,000 = $150,000. B ignores the recovery rate. C uses PD × Recovery × Notional. D is wrong.
Question 801
A bond has face value $1,000,000, and modified duration 5.5. If credit spreads widen by 40 bps, what is the approximate dollar loss?
Select an option first.
Correct answer: A — −$22,000
Explanation: A is correct. Dollar loss ≈ −Spread Duration × Price × Δspread. Assuming spread duration ≈ 5.5 and price = $1,000,000 (at par). ΔP = −5.5 × $1,000,000 × 0.004 = −$22,000. B divides by 10. C multiplies by 10. D uses 1% spread change.
Question 802
A 20-year zero-coupon bond is priced at $311.80 per $1,000 face. What is its YTM (annual)?
Select an option first.
Correct answer: A — 6.00%
Explanation: A is correct. P = F/(1+y)^n → $311.80 = $1,000/(1+y)^20 → (1+y)^20 = 3.2073. (1+y) = 3.2073^(1/20). ln(3.2073) = 1.1656; 1.1656/20 = 0.05828; e^0.05828 = 1.06 → y = 6.00%. B gives price $376.89 (too high).
Question 803
A senior tranche of a CLO has face $80,000,000 out of a total pool of $100,000,000 (equity = $20,000,000). If the pool suffers 15% losses ($15,000,000), what is the loss absorbed by the equity tranche?
Select an option first.
Correct answer: A — $15,000,000
Explanation: A is correct. Total loss = $15M. The equity tranche has $20M in first-loss protection. Since losses ($15M) < equity tranche ($20M), all losses are absorbed by equity. Senior tranche is fully protected. B is the full equity tranche amount. C and D are wrong.
Question 804
A 5-year bond with 7% coupon (annual), $1,000 par, is callable at par in 3 years. The bond is currently priced at $1,060. What is the approximate yield to call (YTC)?
Select an option first.
Correct answer: B — 4.85%
Explanation: B is correct. YTC: Approximate YTC = [$70 + ($1,000 − $1,060)/3] / [($1,000 + $1,060)/2] = [$70 − $20] / [$1,030] = $50/$1,030 = 4.85%. Since the call is at par ($1,000) below current price ($1,060), the YTC is below the coupon rate. A is slightly too low. C is the coupon rate.
Question 805
A loan outstanding = $500,000 with annual amortization of $100,000 at 5% annual interest. What is the year 3 interest payment?
Select an option first.
Correct answer: A — $15,000
Explanation: A is correct. Balance at start of year 3 = $500,000 − 2 × $100,000 = $300,000. Year 3 interest = 5% × $300,000 = $15,000. B uses the original balance. C uses $200,000. D uses $400,000.
Question 806
A sovereign bond yields 4.5% and a comparable corporate bond yields 6.0%. The corporate bond's credit spread is:
Select an option first.
Correct answer: A — 150 bps
Explanation: A is correct. Credit spread = 6.0% − 4.5% = 1.5% = 150 bps. B, C, D use incorrect arithmetic.
Question 807
An ABS pool of $200M has subordination (junior tranche) of $20M. If cumulative losses reach 8% of the pool ($16M), what is the remaining subordination?
Select an option first.
Correct answer: A — $4,000,000
Explanation: A is correct. Original subordination = $20M. Losses absorbed = $16M. Remaining subordination = $20M − $16M = $4M. B is the total losses. C is the original subordination before losses. D would only be correct if losses exceeded $20M.
Question 808
A callable bond has a Z-spread of 250 bps and an OAS of 180 bps. The call option cost to the investor is:
Select an option first.
Correct answer: A — 70 bps
Explanation: A is correct. Option cost = Z-spread − OAS = 250 − 180 = 70 bps. This 70 bps represents the annual yield the investor gives up by having the issuer hold the call option. B is the full Z-spread. C is the OAS. D adds instead of subtracts.
Question 809
If a portfolio's total DV01 is $15,000 per bp and the manager wants to reduce it to $10,000 by selling bonds with DV01 of $2,000 per bp per $10,000,000 par, how much par must be sold?
Select an option first.
Correct answer: A — $25,000,000
Explanation: A is correct. DV01 reduction needed = $15,000 − $10,000 = $5,000. Amount to sell = ($5,000/$2,000) × $10,000,000 = 2.5 × $10,000,000 = $25,000,000. B uses $15,000/$2,000 × $2M. C is $1M off. D overshoots.
Question 810
An MBS pool has outstanding balance $200,000,000 and CPR = 12% per year. Approximate monthly SMM (using SMM ≈ 1 − (1−CPR)^(1/12)):
Select an option first.
Correct answer: A — 1.06%
Explanation: A is correct. SMM = 1 − (1 − 0.12)^(1/12) = 1 − (0.88)^(0.0833) ≈ 1 − 0.98941 = 1.059% ≈ 1.06%. D is CPR/12 (wrong formula). C is too low. B uses 1/12 of CPR directly.
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