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Free CFA Specialized Pathway - Portfolio Management Practice Questions & Answers
250 exam-style Specialized Pathway - Portfolio Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 211
During a RECESSION, which credit spread CURVE is MOST LIKELY to INVERT?
Select an option first.
Correct answer: C — The HY curve only
Explanation: C is correct. The reading quiz confirms: 'While the IG credit spread curve is likely to flatten during periods of economic downturn, it is only the HY curve that typically inverts (i.e., becomes downward sloping), due to the high level of defaults in the short term for HY issuers.' HY issuers face immediate near-term distress during recession, causing short-maturity HY spreads to spike much higher than long-maturity spreads (if the company survives the short term, long-term risk seems lower). IG issuers rarely default, so their curve retains an upward slope.
Question 212
EMPIRICAL DURATION for a HY bond is LOWER than its ANALYTICAL (modified) duration because:
Select an option first.
Correct answer: B — The negative correlation between benchmark yields and credit spreads means HY yields change by less than benchmark yields alone
Explanation: B is correct. The reading explains: 'Since the actual bond price is driven by both spreads and benchmark rates, empirical duration will be lower than analytical duration for low-quality securities.' The example: a HY bond yields 6% over a 2% Treasury (4% spread). When the Treasury falls 100 bps to 1%, the spread widens to 5%, leaving the HY yield unchanged at 6%. The bond price does not change despite the rate move, making empirical duration = 0 versus analytical duration = 4.4. Spreads and rates move inversely, dampening price sensitivity.
Question 213
The YIELD SPREAD of a corporate bond is defined as:
Select an option first.
Correct answer: B — The bond YTM minus the YTM of the closest maturity on-the-run government bond
Explanation: B is correct. The reading defines: 'The simplest measure of spread, the yield spread (or benchmark spread) of a bond is defined as the bond YTM minus the YTM of the closest maturity on-the-run government bond.' It uses only the nearest available government bond without interpolation. The g-spread improves on this by interpolating between adjacent government maturities to find a government benchmark that exactly matches the corporate bond maturity.
Question 214
For a 12-year corporate bond (YTM = 4.5%) with adjacent government bonds at 10 years (YTM = 3.0%) and 20 years (YTM = 5.0%), the G-SPREAD is:
Select an option first.
Correct answer: D — 1.1% (using interpolated 12-year benchmark of 3.4%)
Explanation: D is correct. Weight in 20-year = (12 - 10) / (20 - 10) = 2/10 = 0.2; weight in 10-year = 0.8. Interpolated 12-year government YTM = (0.8 x 3.0%) + (0.2 x 5.0%) = 2.4% + 1.0% = 3.4%. G-spread = 4.5% - 3.4% = 1.1%. Note answer B says 1.0% which is incorrect; D correctly states 1.1%. The reading example confirms: 'the g-spread of the corporate bond = 4.5% - 3.4% = 1.1%.' Yield spread would be 4.5% - 3.0% = 1.5%.
Question 215
In an UPWARD-SLOPING yield curve, the YIELD SPREAD for a 12-year corporate bond (using 10-year government as benchmark) will be COMPARED to the G-SPREAD:
Select an option first.
Correct answer: C — Higher than the g-spread
Explanation: C is correct. The reading quiz confirms: 'The yield spread compares the YTM of the 12-year corporate bond to the nearest maturity on-the-run Treasury YTM. In this case, the nearest maturity is the 10-year maturity. The g-spread compares the YTM to the 12-year interpolated government YTM using the 10 and 15-year maturity Treasuries. Given the yield curve is upward sloping, the 12-year interpolated Treasury YTM will be HIGHER than the 10-year government YTM. This implies that the g-spread will be LOWER than the yield spread.'
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Question 216
For the 12-year corporate bond example with swap spreads of 20 bps (10-year) and 30 bps (20-year), the I-SPREAD is:
Select an option first.
Correct answer: C — 0.88%
Explanation: C is correct. The 10-year swap fixed rate = 3.0% + 0.20% = 3.2%. The 20-year swap fixed rate = 5.0% + 0.30% = 5.3%. Using 80% weight in 10-year and 20% weight in 20-year (same as before): Interpolated 12-year swap fixed rate = (0.8 x 3.2%) + (0.2 x 5.3%) = 2.56% + 1.06% = 3.62%. I-spread = corporate YTM - interpolated swap rate = 4.50% - 3.62% = 0.88%. The reading example confirms this exact figure. The ASW = coupon - interpolated swap rate = 4.30% - 3.62% = 0.68%.
Question 217
The OAS (option-adjusted spread) is the ONLY spread measure appropriate for bonds with embedded options because:
Select an option first.
Correct answer: B — It adjusts the bond cash flows for expected option exercise and removes the option impact from the spread
Explanation: B is correct. The reading states: 'The OAS is the only spread measure appropriate for assessing the credit/liquidity risk of bonds with embedded options. By adjusting the cash flows of the bond to reflect expected interest rate volatility, the uncertainty of the cash flows due to the optionality of the bond has been removed, and the resulting OAS, therefore, does not include any impact of the option on the spread. The OAS measures the spread that is earned for facing the credit and liquidity risk of the issuer.' Think of OAS as the option-REMOVED spread.
Question 218
The CDS BASIS is defined as:
Select an option first.
Correct answer: B — The difference between the CDS spread and the z-spread of the underlying bond
Explanation: B is correct. The reading states: 'The CDS basis is defined as the CDS spread minus the z-spread. This is a useful measure for those trading CDS contracts.' Theoretically, the CDS spread should equal the z-spread since both compensate for the same credit risk. In practice, differences arise due to the underlying bond trading away from par, accrued interest, and idiosyncratic CDS contract features. The CDS basis being positive means CDS protection is more expensive than the bond spread implies.
Question 219
For a CORPORATE FRN paying MRR + 1.25% with a discount margin (DM) of 1.55%, the bond will trade:
Select an option first.
Correct answer: C — Below par because DM (1.55%) exceeds QM (1.25%), so investors require a higher return than the bond pays
Explanation: C is correct. The reading states: 'The FRN will trade below par. The DM of 1.55% is above the QM of 1.25%, which implies that investors require a higher margin above the MRR than that being paid by the FRN. This will cause the bond to trade below par because the future overall discount rate applied to bond cash flows will be higher than the coupon paid.' The analogy: DM plays the role of yield and QM plays the role of coupon. When yield (DM) exceeds coupon (QM), the bond trades below par.
Question 220
During an ECONOMIC RECOVERY, the Z-DM for a corporate FRN is likely to be:
Select an option first.
Correct answer: A — Lower than the DM
Explanation: A is correct. The reading quiz confirms: 'The DM assumes that the yield curve is flat because it is the constant margin above the current MRR required by investors. The Z-DM reflects the term structure of the MRR curve. In an upward-sloping MRR curve environment, the MRR spot rates will be higher than the current MRR as maturity increases, and so the Z-DM will be lower than the DM.' With an upward-sloping MRR curve, future discount rates are higher than today's MRR, requiring a LOWER Z-DM to produce the same bond price.
Question 221
A portfolio has two bonds: Bond X (market value 1,030,000, OAS=120 bps) and Bond Y (market value 955,000, OAS=140 bps). The portfolio OAS is closest to:
Select an option first.
Correct answer: A — Below 130 bps
Explanation: A is correct. The reading quiz calculates: weight of Bond X = 1,030,000 / (1,030,000 + 955,000) = 1,030,000 / 1,985,000 = 51.9%. Since Bond X (OAS=120 bps) has a higher market value weight than Bond Y (OAS=140 bps), the portfolio OAS is pulled toward 120 bps. Portfolio OAS = (0.519 x 120) + (0.481 x 140) = 62.3 + 67.3 = 129.6 bps, which is below 130 bps. The key insight: bond prices include accrued interest when calculating market value weights.
Question 222
A portfolio has bonds A (70% weight, EffSpreadDur=9.0, OAS=180 bps) and B (30% weight, EffSpreadDur=9.5, OAS=400 bps). Index OAS = 200 bps. If index spreads WIDEN by 20 bps, the EXPECTED change in portfolio value using DTS is:
Select an option first.
Correct answer: B — -2.27%
Explanation: B is correct. DTS_A = 9.0 x 180 = 1,620. DTS_B = 9.5 x 400 = 3,800. Portfolio DTS = (0.70 x 1,620) + (0.30 x 3,800) = 1,134 + 1,140 = 2,274. Proportionate index spread change = 20 / 200 = 10%. Expected portfolio value change = -(DTS x proportionate change) = -(2,274 x 0.10) = -227.4 bps = -2.274% approximately -2.27%. The reading example confirms exactly this calculation. DTS captures the fact that higher-spread bonds experience proportionally larger absolute spread changes.
Question 223
A bond has EffSpreadDur = 4.5, current spread = 250 bps, POD = 1.5% annualized, LGD = 55%, and expected spread in six months = 270 bps. The SIX-MONTH EXPECTED EXCESS SPREAD is closest to:
Select an option first.
Correct answer: C — -0.06% (bond is slightly overvalued)
Explanation: C is correct. Using the excess spread formula for a 6-month period: Excess spread = spread income - EffSpreadDur x delta_spread - POD x LGD. Spread income (6-month) = 0.0250 x 0.5 = 0.0125. Spread duration loss = 4.5 x (0.027 - 0.025) = 4.5 x 0.002 = 0.009. Credit loss (6-month) = (0.015 x 0.55) x 0.5 = 0.004125. Excess spread = 0.0125 - 0.009 - 0.004125 = -0.000625 approximately -0.06%. The bond is slightly overvalued (negative excess spread). This matches the reading example conclusion.
Question 224
STRUCTURAL CREDIT MODELS assess probability of default (POD) based on:
Select an option first.
Correct answer: B — The likelihood of the issuer's future asset value falling below the threshold that would trigger default
Explanation: B is correct. The reading defines: 'Structural models assume POD to be driven by the likelihood of the future value of the assets of a borrower falling below the threshold that would trigger default. These models are often referred to as distance to default models because they assess how far away from defaulting an issuer currently is in terms of the volatility of their assets.' Moody's EDF and Bloomberg DRSK are examples. Equity market data (market cap, equity volatility) are used to estimate asset volatility.
Question 225
REDUCED FORM credit models, such as Altman's z-score, differ from structural models in that they:
Select an option first.
Correct answer: C — Look for statistical relationships between macroeconomic conditions/financial ratios and default intensity
Explanation: C is correct. The reading states: 'Reduced form models look for relationships between macroeconomic conditions and the individual characteristics of a borrower, such as financial ratios, to infer default intensity (or periodic POD) for a bond issuer.' Altman's z-score uses financial ratios as inputs to a regression equation to classify default likelihood. This contrasts with structural models which use option-theoretic asset value relative to debt threshold.
Question 226
An Altman z-score calculation gives a result of 4.11. This IMPLIES the issuer has:
Select an option first.
Correct answer: C — Low default risk (z-score above 3.0)
Explanation: C is correct. The reading quiz confirms the calculation from financial ratios gives 4.11, and states: 'This z-score of 4.11 is above the threshold of 3, so we are required to label the company as low default risk.' The z-score interpretation: greater than 3 = low default risk; between 1.8 and 3 = some chance of default; below 1.8 = high default risk (default likely). The reading provides the Altman formula in exam questions, so precise memorization of all components is less critical than interpreting the output.
Question 227
Under a STRUCTURAL CREDIT MODEL, which change would DECREASE the probability of default?
Select an option first.
Correct answer: B — A decrease in the volatility of the issuer share price
Explanation: B is correct. The reading quiz confirms: 'A fall in the volatility (i.e., standard deviation) of equity will imply a fall in the standard deviation of the issuer's assets, which will increase the distance to default (in terms of standard deviations) and, therefore, lower the POD of the issuer.' Structural models are distance-to-default models. The distance is measured in standard deviations of asset value. If asset volatility falls, the same distance to the default threshold represents more standard deviations, reducing POD. Decrease in coverage ratio and increase in leverage both increase POD.
Question 228
The A-rated bond (spread=1.5%, EffSpreadDur=6, POD=0.25%, LGD=60%) and B-rated bond (spread=3.0%, EffSpreadDur=8, POD=3%, LGD=60%) are evaluated assuming spreads widen by 15%. Based on EXCESS SPREAD, the A-rated bond is:
Select an option first.
Correct answer: C — More attractive than the B-rated bond
Explanation: C is correct. The reading quiz calculates: Excess spread for A-rated = 0.015 - [6 x (0.15 x 0.015)] - [0.0025 x 0.6] = 0.015 - 0.01350 - 0.00150 = 0%. Excess spread for B-rated = 0.030 - [8 x (0.15 x 0.030)] - [0.03 x 0.6] = 0.030 - 0.036 - 0.018 = -0.024 or -2.4%. The A-rated bond has 0% excess spread while the B-rated has -2.4%. A-rated is MORE attractive (higher excess spread). The B-rated bond is overvalued given the expected 15% widening in spreads.
Question 229
For a TOP-DOWN credit manager, a NUMERIC RATING SCALE that assigns values of 1, 10, 20, 40 to AAA, AA, A, BBB is PREFERRED over a simple 1, 2, 3, 4 scale because:
Select an option first.
Correct answer: B — It reflects that default rates and losses increase much more rapidly than linearly as ratings decline
Explanation: B is correct. The reading states: 'This approach can understate exposure to credit risk because default rates and losses tend to increase rapidly as the rating declines. Other more weighted scales assign a number that increases much more rapidly than 1, 2, 3, 4 as credit rating declines (e.g., 1, 10, 20, 40 is used by Moody's). Portfolio averages of a weighted scale will show that exposure to credit risk increases at a faster than linear rate, as bond ratings decline.' The non-linear scale better captures the actual risk profile.
Question 230
The DEFENSIVE factor in fixed-income credit strategies suggests that:
Select an option first.
Correct answer: B — Lower-risk (shorter-duration) assets offer superior risk-adjusted returns to higher-risk assets
Explanation: B is correct. The reading states: 'Defensive: Empirical observation that lower-risk assets offer higher risk-adjusted returns than higher risk assets.' This is the fixed-income equivalent of the low-volatility anomaly in equities. In the context of credit, this means shorter-duration, higher-quality bonds may offer better risk-adjusted returns than would be predicted by standard asset pricing models. This is one of four credit factors identified: carry, defensive, momentum, and value.
Question 231
GREEN BONDS in the context of ESG fixed-income investing are:
Select an option first.
Correct answer: C — Bonds issued to raise financing for projects that reduce air pollution, improve recycling, and improve environmental sustainability
Explanation: C is correct. The reading states: 'Green bonds are bonds issued to raise finances for projects that reduce air pollution, improve recycling, promote environmental remediation (i.e., reduce contamination of the environment), and improve the sustainability of building construction. Such bonds have shown very strong demand from investors in recent years.' Green bonds are a way to directly fund ESG-specific initiatives, one of the three main ESG techniques in fixed income alongside negative screening and use of ESG ratings.
Question 232
An active credit manager holds an illiquid corporate bond position equivalent to 10x average daily volume. To MANAGE INTEREST RATE RISK while slowly liquidating the position, the manager should:
Select an option first.
Correct answer: B — Enter a pay-fixed swap and unwind the swap OVER TIME as the bond is sold
Explanation: B is correct. The reading quiz confirms: 'It will take a significant amount of time to carefully liquidate such a large position. In the meantime, the manager should hedge the interest rate exposure of the fixed-coupon received on the bond by paying fixed under an interest rate swap. As the bond is sold over time, the swap should be unwound to match the remaining bond position.' Pay-fixed offsets the receive-fixed exposure of the corporate bond coupon. As bond is sold, the matching hedge is reduced concurrently.
Question 233
INCREMENTAL VaR is the MOST APPROPRIATE measure for a manager who wants to assess the impact of:
Select an option first.
Correct answer: C — INCREASING or DECREASING an active position on the overall portfolio VaR
Explanation: C is correct. The reading quiz confirms: 'Incremental VaR measures the impact of changing positions in the portfolio on overall VaR.' The reading defines: 'Incremental VaR (IVaR) (or partial VaR) measures the change in VaR from adding or removing a position in a portfolio.' CVaR (conditional VaR) measures expected loss in the tail. Relative VaR measures VaR relative to a benchmark. Standard VaR defines the minimum loss at a given confidence level.
Question 234
The PARAMETRIC VaR method is MOST LIKELY to PERFORM POORLY for portfolios containing:
Select an option first.
Correct answer: C — Bonds with embedded options or other non-linear instruments
Explanation: C is correct. The reading states: 'The parametric VaR method assumes returns are normal and uses the parameters (mean and standard deviation) to calculate the loss at a given percentile. The disadvantage is that it does not perform well for portfolios with non-normal distribution, such as those containing options.' Options create non-linear payoff profiles that produce non-normal return distributions, making the normality assumption of parametric VaR inappropriate. Bond portfolios with callable or putable bonds are examples where parametric VaR can be misleading.
Question 235
The HISTORICAL SIMULATION method for VaR has which KEY ADVANTAGE over the parametric method?
Select an option first.
Correct answer: B — It uses actual historical market movements and handles non-normal return distributions
Explanation: B is correct. The reading states: 'Historical simulation applies historical movements in key risk factors to the existing portfolio in order to generate a return distribution. The advantage of this historical VaR is that it uses actual market data and can handle portfolios with non-normal returns.' The disadvantage is 'it is heavily dependent on the historical sample used, and this history may not be a guide to the future.' Monte Carlo (C) allows non-normal user-specified distributions. Parametric (A) uses only mean and standard deviation.
Question 236
A 15-year bond position of $100 million with MD=12 and daily yield volatility of 1.5% annualized. The 99% confidence (1% VaR) ONE-MONTH VaR is closest to:
Select an option first.
Correct answer: B — $12.1 million
Explanation: B is correct. Monthly yield volatility = (1.5% / sqrt(252)) x sqrt(21) = 1.5% / 15.875 x 4.583 = 0.433%. At 99% confidence (1% VaR), the threshold = 2.33 x 0.433% = 1.009% = 100.89 bps. Portfolio impact = -MD x delta_y = -12 x 1.0089% = -12.107%. Dollar VaR = 12.107% x $100M = $12.107 million approximately $12.1 million. The reading confirms this exact calculation. The key steps: annualized daily volatility to monthly, then apply 2.33 sigma at 1% tail.
Question 237
In a CDS contract, the PROTECTION SELLER is LONG RISK because:
Select an option first.
Correct answer: B — The protection seller receives premiums but must pay if a credit event occurs, so faces the credit risk of the reference entity
Explanation: B is correct. The reading states: 'The protection seller suffers losses if a credit event occurs and is, therefore, referred to as being long risk (i.e., they face the credit risk of the reference issuer).' The protection seller receives periodic fixed coupon payments but bears the credit risk: if the reference entity defaults, the protection seller must pay the protection buyer. Conversely, the protection buyer is SHORT risk, profiting when the issuer's creditworthiness deteriorates.
Question 238
For a HY CDS contract with CDS spread of 5.5% and effective spread duration of 4.5, the UPFRONT PREMIUM paid by the protection BUYER is:
Select an option first.
Correct answer: A — 2.25% of notional (buyer pays seller)
Explanation: A is correct. HY standardized fixed coupon = 5%. CDS spread = 5.5% which is ABOVE the 5% fixed coupon. Since the protection buyer pays a fixed coupon BELOW what is fair, they must TOP UP with an upfront payment to the seller. Upfront premium = (CDS spread - fixed coupon) x EffSpreadDur = (5.5% - 5.0%) x 4.5 = 0.5% x 4.5 = 2.25% of notional, PAID BY THE BUYER TO THE SELLER. The reading states: 'If the fair CDS spread is above the standardized fixed coupon, the protection buyer needs to make an upfront premium payment to the protection seller.'
Question 239
For a HY CDS contract with 5% fixed coupon and CDS spread 5.5%, EffSpreadDur = 4.5, the CDS PRICE as a percentage of par is:
Select an option first.
Correct answer: C — 97.75%
Explanation: C is correct. CDS price = 1 + (fixed coupon - CDS spread) x EffSpreadDur = 1 + (0.05 - 0.055) x 4.5 = 1 + (-0.005 x 4.5) = 1 - 0.0225 = 0.9775 = 97.75%. The reading confirms: 'The quick way to derive the CDS price is to notice that the CDS spread is higher than the fixed coupon; hence, we deduct the upfront premium from par.' HY issuers have CDS spreads above the 5% fixed coupon, so their CDS trades below par. IG issuers have CDS spreads below the 1% fixed coupon, so their CDS trades above par.
Question 240
If the CDS spread on a HY bond IMMEDIATELY FALLS from 5.5% to 5.4% after the manager buys protection, the mark-to-market P&L to the PROTECTION BUYER is:
Select an option first.
Correct answer: B — Loss of 0.45%
Explanation: B is correct. The reading states: 'The price impact of a change in spread = -delta_CDS spread x EffSpreadDur = -(5.40% - 5.50%) x 4.5 = 0.45%. Note that the protection buyer would suffer a mark-to-market LOSS here of 0.45% due to the fall in spread.' The protection buyer is SHORT risk and profits when spreads WIDEN. When spreads NARROW, the protection becomes less valuable, generating a mark-to-market loss. This is the opposite of a long bond position.
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