CFA Program Level I for February 2024

Fixed Income (Solution)

1.
A. Incorrect because a bond that is currently callable may be retired by the issuer, but the
issuer is not required to do 50.
B. Incorrect because a step-up note has a coupon rate that increases over time according to
a predetermined schedule.
C. Correct. A sinking fund provision requires retirement of a portion of the bond's principal
every year, rather than retirement of the entire issue at maturity.
Fixed Income: describe common cash flow structures of fixed-income instruments and
contrast cash flow contingency provisions that benefit issuers and investors

2.
A. Incorrect because the yield to maturity converted to a quarterly basis should be
expressed in annual terms just like the semiannual yield to maturity: for bonds maturing in
more than one year, investors want an annualized and compounded yield-to-maturity. The
formula for converting m periods to n periods per year is (1 + APRm /m)m = (1 + APRn /n)n.
Thus, (1+0.08/2)² = (1 + APR4/4)4 <=> APR4/4= 1.98% ≠ APR4 .
B. Incorrect because the yield to maturity converted to a quarterly basis cannot be
calculated by simply scaling the yield to maturity with a periodicity that is twice longer: APR 4
≠(1 + APR2)1/2 - 1 = 1.081/2 – 1 = 3.92%. The correct formula for converting m periods to n
periods per year is (1 + APRm/m)m = (1 + APR>n/n)n
C. Correct because (1 + APR2/2)² = (1 + APR4/4)4 for annual percentage rates using
semiannual and quarterly basis (APR2 and APR4, respectively). This gives (1+0.08/2)² = (1 +
APR4/4)4 = APR4/4 = 1.98% and APR4 = 4 x 1.98% = 7.92%.
Fixed Income: calculate annual yield on a bond for varying compounding periods in a year

3.
A. Incorrect because this describes modified duration. Modified duration provides an
estimate of the percentage price change for a bond given a change in its yield-to-maturity
B. Incorrect because the duration of a callable bond is not the sensitivity of the bond price
to a change in the yield- to-worst (Le.. the lowest of the yield-to-maturity, yield-to-first-call,
yield-to-second-call, and so forth). In contrast to effective duration, key rate durations help

1
CFA Program Level I for February 2024

identify 'shaping risk' for a bond-that is, a bond's sensitivity to changes in the shape of the
benchmark yield curve (e.g., the yield curve becoming steeper or flatter).
C. Correct because key rate duration (or partial duration) is a measure of a bond's sensitivity
to a change in the benchmark yield curve at a specific maturity segment. In contrast to
effective duration, key rate durations help identify 'shaping risk for a bond-that is, a bond's
sensitivity to changes in the shape of the benchmark yield curve ( e.g., the yield curve
becoming steeper or flatter).
Fixed Income: define key rate duration and describe its use to measure price sensitivity of
fixed-income instruments to benchmark yield curve changes

4.

A. Correct because %𝛥𝑃𝑉 𝐹𝑢𝑙𝑙 = (−𝐴𝑛𝑛𝑀𝑜𝑑𝐷𝑢𝑟 × 𝛥𝑌𝑖𝑒𝑙𝑑) + [(0.5 × 𝐴𝑛𝑛𝑐𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 ×

𝛥(𝑌𝑖𝑒𝑙𝑑)2 ] = (−6.9 × 0.0075) + (0.5 × −212 × 0.00752 ) = −0.05175 − 0.0059625 =
0.0577125, rounded to 5.77%. The percentage decline in price = -0.0577125 x 99.4 = -
5.7366, and the bond price = 99.4 – 5.7366 = 93.6634, rounded to 93.66.
B. Incorrect because the price is calculated using par instead of 99.4 Price ≠ 100 - 5.74 =
94.26.
C. Incorrect because the convexity adjustment is input as a positive number:(-6.9 x 0.0075) +
(0.5 x 212 × 0.00752) = -0.05175 + 0.0059625 = 0.04579, rounded to 4.58%. The percentage
decline in price = 0.04579 x 99.4 = 4.5515, and the bond price = 99.4 - 4.5515 = 94.8485,
rounded to 94.85.
Fixed Income: calculate the percentage price change of a bond for a specified change in
yield, given the bond's duration and convexity

5.
A. Incorrect because a buy-and-hold investor has a higher total return if interest rates rise
due to the unexpected excess coupon reinvestment proceeds. If interest rates fall, a buy-
and-hold investor realizes no market price returns as he is redeemed at par at maturity.
B. Incorrect because a buy-and-hold investor has a higher total return if interest rates rise
due to the unexpected excess coupon reinvestment proceeds. If interest rates fall, a buy-
and-hold investor realizes no market price returns as he is redeemed at par at maturity. This
choice may be attractive to uninformed candidates who focus on the buy-and-hold investor,
and not any market interest rate changes.
C. Correct because a long-term investor faces coupon reinvestment risk as well as market
price risk if the bond needs to be sold prior to maturity. An [buy-and-hold] investor [in a 10-
year bond) with a 10-year time horizon is concerned only with coupon reinvestment risk.
This situation assumes of course, that the issuer makes all of the coupon and principal

2
CFA Program Level I for February 2024

payments as scheduled. The buy-and-hold investor has a higher total return if interest rates
rise and a lower total return if rates fall
Fixed Income: describe the relationships among a bond's holding period return, its
Macaulay duration, and the investment horizon;

6.
A. Incorrect because the coupon of a step-up coupon bond, which may be fixed or floating,
increases by specified margins at specified dates. It does not allow the issuer to pay interest
in the form of additional amounts of the bond issue in lieu of a cash payment.
B. Incorrect because a deferred coupon bond, sometimes called a split coupon bond, pays
no coupons for its first few years but then pays a higher coupon than it otherwise normally
would for the remainder of its life. It does not allow the issuer to pay interest in the form of
additional amounts of the bond issue in lieu of a cash payment
C. Correct because a payment-in-kind (PIK) coupon bond typically allows the issuer to pay
interest in the form of additional amounts of the bond issue rather than as a cash payment
Fixed Income: describe common cash flow structures of fixed-income instruments and
contrast cash flow contingency provisions that benefit issuers and investors

7.
A. Incorrect because in contrast [to asset-backed securities], in the case of covered bonds,
the pool of assets remains on the financial institution's balance sheet. In the event of
default, bondholders have recourse against both the financial institution and the cover pool.
B. Incorrect because in contrast [to asset-backed securities], in the case of covered bonds,
the pool of assets remains on the financial institution's balance sheet. In the event of
default, bondholders have recourse against both the financial institution and the cover pool.
C. Correct because a covered bond is a debt obligation backed by a segregated pool of
assets called a "cover pool" in the event of default, bondholders have recourse against both
the financial institution and the cover pool.
Fixed Income: describe characteristics and risks of covered bonds and how they differ from
other asset-backed securities

8.
A. Incorrect because the seller of the collateral, sometimes called the depositor is the
corporation that originated the loans. They are sold to an SPE and held by the trustee

3
CFA Program Level I for February 2024

B. Incorrect because the SPE purchases the loans or receivables and uses them as collateral
to issue the ABS After the sale is completed, it is [the SPE], not [the depositor/seller], that
legally owns them. The SPE owns the collateral but does not hold the collateral, and
although the trustee does not own the underlying collateral it does hold it.
C. Correct because a trustee or trustee agent is typically a financial institution with trust
powers that safeguards the assets after they have been sold to the SPE, holds the funds due
to the ABS holders until they are paid, and provides periodic information to the ABS holders
Fixed Income: describe securitization, including the parties and the roles they play

9.
A. Correct because a mortgage pass-through security's coupon rate is called the pass-
through rate. The pass- through rate is lower than the mortgage rate on the underlying pool
of mortgages by an amount equal to the servicing and other administrative fees. The pass-
through rate that the investor receives is said to be "net interest" or "net coupon.
B. Incorrect because not all of the mortgages that are included in a pool of securitized
mortgages have the same mortgage rate and the same maturity. The WAC is calculated by
weighting the mortgage rate of each mortgage in the pool by the percentage of the
outstanding mortgage balance relative to the outstanding amount of all the mortgages in
the pool. This rate, less servicing and other administrative fees, determines the pass-
through rate
C. Incorrect because a mortgage pass-through security's coupon rate is called the pass-
through rate. The pass- through rate is lower than the mortgage rate on the underlying pool
of mortgages by an amount equal to the servicing and other administrative fees. The pass-
through rate that the investor receives is said to be 'net interest' or 'net coupon"
Fixed Income: describe types and characteristics of residential mortgage-backed securities,
including mortgage pass-through securities and collateralized mortgage obligations, and
explain the cash flows and risks for each type

10.
A. Incorrect because the formula converts from an effective annual yield to a semiannual-
pay yield:
≠ ((1+ yield)0.5 - 1) x 2 = ((1+0.0366)0.5 - 1) x 2= (1.018136 - 1) x 2 = .036272 ≈ 3.63%.
B. Correct because an effective annual rate has a periodicity of one because there is just one
compounding period in the year. No calculations are required based on the intuitive idea
that due to semi-annual compounding, the effective annual yield must be slightly higher.
The formula to calculate the effective annual yield of a semi-annual pay bond is:
= (1 + yield/2)² - 1 = (1 + 0.0366/2)2 – 1 = 1.036935 - 1.036935 ≈ 3.69%

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CFA Program Level I for February 2024

C. Incorrect because the the yield is not divided by 2. The formula used to calculate the
effective annual yield of a semi-annual pay bond:
≠ (1+ yield)² - 1 = (1 + 0.0366)2-1 = 1.07454 – 1 = .07454 ≈ 7.45%.
Fixed Income: calculate annual yield on a bond for varying compounding periods in a year

11.
A. Incorrect because this is part of the prospectus. Another important legal document is the
prospectus, which describes the structure of the securitization.
B. Correct because an important legal document is the purchase agreement between the
seller of the collateral and the SPE, which sets forth the representations and warranties that
the seller makes about the assets sold. These representations and warranties assure
investors about the quality of the assets.
C. Incorrect because this is part of the prospectus. Securitizations often use several forms of
credit enhancements, which are documented in the prospectus.
Fixed Income: describe securitization, including the parties and the roles they play

12.
A. Incorrect because the denominator is incorrectly multiplied by 2, as happens in the
calculation of approximate duration:
[96.3+95.8]−[2×96]
= 521.
2×(0.001)2 ×(96)

(𝑃𝑉_)+(𝑃𝑉+ )−[2𝑥(𝑃𝑉0 )]
B. Correct because ApproxCon = (𝛥𝑌𝑖𝑒𝑙𝑑)2 ×(𝑃𝑉0 )

[96.3+95.8]−[2×96]
Therefore the approximate convexity of this bond = (0.001)2 ×(96)
= 1.042

C. Incorrect because the approximate convexity is incorrectly calculated as approximate

duration, with a mistake in that the change in yield (0.001) is squared:
[96.3−95.8]
(0.001)2 × 2 ×(96)
= 2.604.

Fixed Income: calculate and interpret convexity and describe the convexity adjustment

13.
A. Incorrect because a par curve is a sequence of yields-to-maturity such that each bond is
priced at par value. Par rates are not break-even reinvestment rates.
B. Incorrect because the spot rate is a sequence of yields-to-maturity on zero-coupon bonds.
A forward rate links one spot rate to another and for this reason can be characterized as a
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CFA Program Level I for February 2024

break-even reinvestment rate. A spot rate alone is, however, not a break-even reinvestment
rate
C. Correct because an implied forward rate is a break-even reinvestment rate. It links the
return on an investment in a shorter-term zero-coupon bond to the return on an investment
in a longer-term zero-coupon bond.
Fixed Income: define spot rates and the spot curve, and calculate the price of a bond using
spot rates

14.
A. Incorrect because the bond price (or value) determined using the spot rates is sometimes
referred to as the bond's 'no-arbitrage value'
If the current market price equals the no-arbitrage value, discounting the cash flows by
either spot rates or yield to maturity arrives to the same price. The level of the current
market price vis a vis par has no bearing the no-arbitrage value.
B. Correct because bond price (or value) determined using the spot rates is sometimes
referred to as the bond's 'no-arbitrage value'
If the current market price equals the 'no-arbitrage value, discounting the cash flows by
either spot rates or yield to maturity arrives to the same price.
C. Incorrect because bond price (or value) determined using the spot rates is sometimes
referred to as the bond's 'no-arbitrage value'.
If the current market price equals the no-arbitrage value, discounting the cash flows by
either spot rates or yield to maturity arrives to the same price. The level of the current
market price vis a vis par has no bearing the no- arbitrage value.
Fixed Income: define spot rates and the spot curve, and calculate the price of a bond using
spot rates

15.
A. Incorrect because all creditors at the same level of the capital structure are treated as
one class, thus, a senior unsecured bondholder whose debt is due in 30 years has the same
pro rata claim in bankruptcy as one whose debt matures in six months. This provision is
referred to as bonds ranking pari passu ('on an equal footing") in right of payment.
B. Correct because both bonds represent forms of senior unsecured debt and therefore, all
creditors are at the same level of the capital structure and treated as one class, thus, a
senior unsecured bondholder whose debt is due in 30 years has the same pro rata claim in
bankruptcy as one whose debt matures in six months. This provision is referred to as bonds
ranking pari passu ('on an equal footing") in right of payment.

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CFA Program Level I for February 2024

C. Incorrect because all creditors at the same level of the capital structure are treated as
one class; thus, a senior unsecured bondholder whose debt is due in 30 years has the same
pro rata claim in bankruptcy as one whose debt matures in six months. This provision is
referred to as bonds ranking pari passu ('on an equal footing') in right of payment
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

16.
A. Incorrect because putable bonds are beneficial for the bondholder by guaranteeing a pre-
specified selling price at the redemption dates. If interest rates rise after the issue date, thus
depressing the bond's price, the bondholders can put the bond back to the issuer and get
cash. This cash can be reinvested in bonds that offer higher yields, in line with the higher
market interest rates. Thus reinvestment risk is lower for a putable bond than for a callable
bond, all else being equal
B. Correct because callable bonds present investors with a higher level of reinvestment risk
than non-callable bonds, that is, if the bonds are called, bondholders have to reinvest funds
in a lower interest rate environment
C. Incorrect because a convertible bond can be viewed as the combination of a straight
bond (option-free bond) plus an embedded equity call option. Convertible bonds can also
include additional provisions, the most common being a call provision. As there is no call
provision applicable in this instance, reinvestment risk will be lower than for an equivalent
bond with a call provision: callable bonds present investors with a higher level of
reinvestment risk than non-callable bonds, that is, if the bonds are called, bondholders have
to reinvest funds in a lower interest rate environment
Fixed Income: describe common cash flow structures of fixed-income instruments and
contrast cash flow contingency provisions that benefit issuers and investors

17.
A. Incorrect because a bond rated A-can be downgraded one category (to BBB-) and still be
an investment grade bond
B. Incorrect because a bond rated BB- is already below investment grade before any
downgrade
C. Correct because BBB- is the lowest rating for investment grade bonds. A one-category
downgrade (from BBB- to BB-) would make the bond non-investment grade
Fixed Income: describe the uses of ratings from credit rating agencies and their limitations

7
CFA Program Level I for February 2024

18.
A. Correct because another factor considered by rating agencies is structural subordination,
which can arise when a corporation with a holding company structure has debt at both its
parent holding company and operating subsidiaries. Debt at the operating subsidiaries will
get serviced by the cash flow and assets of the subsidiaries before funds can be passed
("upstreamed") to the holding company to service debt at that level.
B. Incorrect because cross-default provisions, occur when default such as non-payment of
interest on one bond trigger default on all outstanding debt. This is not structural
subordination
C. Incorrect because rating agencies will typically provide both issuer and issue ratings,
particularly as they relate to corporate debt. Terminology used to distinguish between
issuer and issue ratings includes corporate family rating. This is not structural subordination.
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

19.
A. Correct because as times passes during the coupon period (moving from right to left in
the diagram), the Macaulay duration declines smoothly and then jumps upward after the
coupon is paid. The usual pattern is that longer times-to-maturity correspond to higher
Macaulay duration statistics. This pattern always holds for bonds trading at par value or at a
premium above par Conversely, a shorter time to maturity corresponds to a lower Macaulay
duration during the coupon period.
B. Incorrect because the usual pattern is that longer times-to-maturity correspond to higher
Macaulay duration statistics. This pattern always holds for bonds trading at par value or at a
premium above par Macaulay duration statistic stays constant if the bond is a perpetuity.
C. Incorrect because if the bond is priced at a discount [not at a premium], a longer time-to-
maturity might lead to a lower duration. This situation only occurs if the coupon rate is low
(but not zero) relative to the yield and the time- to-maturity is long. Conversely, only for
special cases of discount bonds, a shorter time to maturity might lead to a higher duration
statistic
Fixed Income: explain how a bond's maturity, coupon, and yield level affect its interest rate
risk

20.
A. Correct because bonds rated Baa3 or higher by Moody's and BBB- or higher by Standard
& Poor's and Fitch are considered investment grade.

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CFA Program Level I for February 2024

B. Incorrect because bonds rated Baa3 or higher by Moody's and BBB- or higher by Standard
& Poor's and Fitch are considered investment grade
C. Incorrect because bonds rated Baa3 or higher by Moody's and BBB- or higher by Standard
& Poor's and Fitch are considered investment grade
Fixed Income: describe fixed-income market segments and their issuer and investor
participants

21.
A. Incorrect because EBITDA/interest is a coverage ratio, not a leverage ratio. There are a
few measures of leverage used by credit analysts. The most common are the debt/capital,
debt/EBITDA, and measures of funds or cash flows/debt ratios.
B. Correct because coverage ratios measure an issuer's ability to meet-to "cover-its interest
payments. The two most common are the EBITDA/interest expense and EBIT/interest
expense ratios.
C. Incorrect because while there are several measures of cash flow and profitability used in
credit analysis, EBITDA/interest is not a measure of profitability EBITDA is a commonly used
measure of cash flow that takes operating income and adds back depreciation and
amortization expense because those are noncash items.
Fixed Income:calculate and interpret financial ratios used in credit analysis

22.
A. luconect because commercial paper is a short-term unsecured promissory note issued in
the public marker or via a private placement that represents a debt obligation of the issuer
Being unsecured the issuer is not required to pledge collateral
B. Correct ancalase credit that agencies often require that commercial paper issuers secure
a backup line of credit from banks
C. Incorrect because maturities for US commercial paper typically range from a few days up
to 270 days.
Fixed Income: compare short-term funding alternatives available to corporations and
financial institutions

9
CFA Program Level I for February 2024

23.
A. Incorrect because it is the coupon of the bond.
B. Correct because current yield is calculated as ($4.5 / $85.70) = 5.25%.
C. Incorrect because it is calculated as follows:
100 - 85.70 = 14.30
14.30 / 10 = 1.43.
4.5 + 1.43 = 5.93
Fixed Income: compare, calculate, and interpret yield and yield spread measures for fixed-
rate bonds

24.
A. Correct because collateralized debt obligation (CDO) is a generic term used to describe a
security backed by a diversified pool of one or more debt obligations: CDOs backed by ABS,
RMBS, CMBS, and other CDOs are structured finance CDOS.
B. Incorrect because collateralized debt obligation (CDO) is a generic term used to describe a
security backed by a diversified pool of one or more debt obligations. CDOs backed by
leveraged bank loans are collateralized loan obligations (CLOS)
C. Incorrect because collateralized debt obligation (CDO) is a generic term used to describe a
security backed by a diversified pool of one or more debt obligations CDOs backed by
corporate and emerging market bonds are collateralized bond obligations (CBOs).
Fixed Income: describe collateralized debt obligations, including their cash flows and risks

25.
A. Incorrect because it uses the current price instead of the price if interest rates increase in
the numerator = (𝑃𝑉+ − 𝑃𝑉0 ) / (2 × 𝛥curve x 𝑃𝑉0) = (100.75 - 100.00) / (2 x 0.001 x 100.00) =
3.75.
B. Correct because effective duration - (𝑃𝑉+ − 𝑃𝑉0 ) / (2 × 𝛥curve x 𝑃𝑉0) = (100.75 – 99.26) /
(2 x 0.001 x 100.00) = 7.45.
C. Incorrect because it uses the current price instead of the price if interest rates increase in
the numerator and fails to multiply by 2 in the denominator, = (𝑃𝑉+ − 𝑃𝑉0 ) / (𝛥curve x 𝑃𝑉0)
= (100.75 - 100.00) / (0.001 x 100.00) = 7.50.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

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CFA Program Level I for February 2024

26.
A. Incorrect because this response uses 1% for the change in the benchmark yield curve
(ACurve), instead of 0.5%. Effective duration = (𝑃𝑉− − 𝑃𝑉+ ) / (2 × 𝛥curve x 𝑃𝑉0) = ($198
million - $174 million) / (2 x 0.01 x $186 million) = 6.4516 ≈ 6.5.
B. Correct because effective duration = (𝑃𝑉− − 𝑃𝑉+ ) / (2 × 𝛥curve x 𝑃𝑉0) = ($198 million -
$174 million) / (2 x 0.005 x $186 million) = 12.9032 ≈ 12.9.
C. Incorrect because this response uses an incorrect formula for effective duration; (𝑃𝑉− −
𝑃𝑉+ ) / (𝛥curve x 𝑃𝑉0) = ($198 million - $174 million)/(0.005 x $186 million) = 25.8065 ≈
25.8.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

27.
A. Incorrect because modified duration is a yield duration statistic. There are several types
of bond duration. In general, these can be divided into yield duration and curve duration.
Yield duration is the sensitivity of the bond price with respect to the bond's own yield-to-
maturity.
B. Correct because effective duration is a curve duration statistic in that it measures interest
rate risk in terms of a parallel shift in the benchmark yield curve
C. Incorrect because Macaulay duration is a weighted average of the time to receipt of . the
bond's promised payments, where the weights are the shares of the full price that
correspond to each of the bond's promised future payments
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

28.
A. Incorrect because bonds issued and traded on the Eurobond market are called
Eurobonds, and they are named after the currency in which they are denominated. For
example, Eurodollar and Euroyen bonds are denominated in US dollars and Japanese yens,
respectively. Bonds that are denominated in euros are called euro- denominated
Eurobonds.
B. Correct because Eurobonds, domestic, and foreign bonds are now registered bonds for
which ownership is recorded by either name or serial number.
C. Incorrect because Eurobonds are issued outside the jurisdiction of any single country, are
usually unsecured, and may be denominated in any currency, including the issuer's domestic
currency.

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CFA Program Level I for February 2024

Fixed Income: describe how legal, regulatory, and tax considerations affect the issuance and
trading of fixed-income securities

29.
A. Correct because compounding more frequently within the year results in a lower (more
negative) yield-to- maturity.
B. Incorrect because compounding more frequently within the year results in a lower (more
negative) yield-to- maturity. Converting the annualized yield-to-maturity to quarterly and
monthly compounding results in the same rates of return.
C. Incorrect because compounding more frequently within the year results in a lower (more
negative) yield-to- maturity.
Fixed Income: calculate annual yield on a bond for varying compounding periods in a year

30.
A. Incorrect because Expected loss = Default probability x (1 - Recovery rate). Since expected
loss is affected by changes in the recovery rate, it is not independent of the recovery rate.
B. Correct because Expected loss = Default probability x Loss severity given default, where
loss severity is often expressed as (1- Recovery rate), where the recovery rate is the
percentage of the principal amount recovered in the event of default. Thus expected loss
can also be written as Expected loss = Default probability x (1- Recovery rate), which means
that the higher the recovery rate, the lower the expected loss.
C. Incorrect because the relationship Expected loss = Default probability x (1 - Recovery rate)
implies that expected loss increases when the recovery rate decreases and vice versa, hence
it does not change proportionally to the recovery rate.
Fixed Income: describe credit risk and its components, probability of default and loss given
default

31.
A. Incorrect because some fixed-rate bonds are not actively traded it is common to estimate
the market discount rate and price based on the quoted or flat prices of more frequently
traded comparable bonds. These comparable bonds have similar times-to-maturity, coupon
rates, and credit quality. This estimation process is called matrix pricing. Highly liquid bonds
are priced based on actual market pricing rather than matrix pricing.

12
CFA Program Level I for February 2024

B. Correct because for bonds that are not yet issued it is common to estimate the market
discount rate and price based on the quoted or flat prices of more frequently traded
comparable bonds. These comparable bonds have similar times-to-maturity, coupon rates,
and credit quality. This estimation process is called matrix pricing.
C. Incorrect because for comparable bonds that have similar times-to-maturity, coupon
rates, and credit quality the estimation process is called matrix pricing. Bonds with uncertain
credit quality are not good candidates for matrix pricing
Fixed Income: describe matrix pricing

32.
A. Incorrect because for a non-recourse mortgage, the borrower may have an incentive to
default on an underwater mortgage and allow the lender to foreclose on the property, even
if resources are available to continue to make mortgage payments. This type of default by a
borrower is referred to as a "strategic default. Therefore, the risk of a strategic default is
higher (not lower) for a non-recourse mortgage.
B. Incorrect because for a non-recourse mortgage, the borrower may have an incentive to
default on an underwater mortgage and allow the lender to foreclose on the property, even
if resources are available to continue to make mortgage payments. This type of default by a
borrower is referred to as a "strategic default." Therefore, the risk of a strategic default is
higher (not the same) for a non-recourse mortgage.
C. Correct because for a non-recourse mortgage, the borrower may have an incentive to
default on an underwater mortgage and allow the lender to foreclose on the property, even
if resources are available to continue to make mortgage payments. This type of default by a
borrower is referred to as a "strategic default. In countries where residential mortgages are
recourse loans, a strategic default is less likely because the lender can seek to recover the
shortfall from the borrower's other assets and/or income. Therefore, the risk of a strategic
default is higher for a non-recourse mortgage
Fixed Income: describe fundamental features of residential mortgage loans that are
securitized

33.
A. Correct because effective duration is essential to the measurement of the interest rate
risk of a complex bond, such as a bond that contains an embedded call option. In brief, a
callable bond does not have a well-defined internal rate of return (yield-to-maturity).
Therefore, yield duration statistics, such as modified and Macaulay durations, do not apply
effective duration is the appropriate duration measure

13
CFA Program Level I for February 2024

B. Incorrect because in brief, [an option embedded) bond does not have a well-defined
internal rate of return (yield- to-maturity). Therefore, yield duration statistics, such as
modified and Macaulay durations, do not apply; effective duration is the appropriate
duration measure.
C. Incorrect because in brief. [an option embedded) bond does not have a well-defined
internal rate of return (yield- to-maturity). Therefore, yield duration statistics, such as
modified and Macaulay durations, do not apply effective duration is the appropriate
duration measure.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

34.
A. Correct because effective duration is essential to the measurement of the interest rate
risk of a complex bond, such as a bond that contains an embedded call option. The problem
is that future cash flows are uncertain because they are contingent on future interest rates.
The issuer's decision to call the bond depends on the ability to refinance the debt at a lower
cost of funds. Effective duration is the appropriate duration measure.
B. Incorrect because a callable bond does not have a well-defined internal rate of return
(yield-to-maturity). Therefore, yield duration statistics, such as modified and Macaulay
durations, do not apply; effective duration is the appropriate duration measure.
C. Incorrect because effective duration measures the bond's sensitivity to changes in the
benchmark yield curve and not changes in credit spread, which are measured by other
means (pricing models). This curve duration measure [effective duration] indicates the
bond's sensitivity to the benchmark yield curve-in particular, the government par curve-
assuming no change in the credit spread. A pricing model can be used to determine a 'credit
duration statistic-that is, the sensitivity of the bond price to a change in the credit spread.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

35.
A. Incorrect because the price of the bond is calculated using as discount rates the average
of the spot rates; (6% + 5% + 4%)/3 = 15%/3 = 5%. Hence, PV ≠ 4/(1.05)¹ + 4/(1.05)2 +
104/(1.05)3 = 4/1.05 + 4/1.1025+ 104/1.157625 = 3.8095 + 3.6281 + 89.8391= 97.276 ≈
97.28.
B. Correct because given the spot rates, the price of a bond can be calculated using the
following formula: PV = [PMT/(1+𝑍1 )1+ PMT/(1+ 𝑍2 )²+...+ (PMT + FV)/(1+ 𝑍𝑁 )N ] Hence, PV =
4/(1+0.06)1 + 4/(1+0.05)² + (4 + 100)/(1+0.04)3 = 4/1.06 + 4/1.1025+ 104/1.1249 = 3.77358 +
3.62812 + 92.4556 = 99.8573 ≈ 99.86.

14
CFA Program Level I for February 2024

C. Incorrect because the price of the bond is calculated using the 3-year spot rate as
discount rate for all cash flows.
Hence, PV ≠ 4/(1 + 0.04)¹ + 4/(1 + 0.04)2 + (4 + 100)/(1 + 0.04)3 = 4/1.04 + 4/1.0816 +
104/1.1249 = 3.8461 + 3.6982 + 92.4527 = 99.9969 ≈ 100.00.
Fixed Income: define spot rates and the spot curve, and calculate the price of a bond using
spot rates

36.
A. Incorrect because for the same coupon rate and time-to-maturity, the percentage price
change is greater (in absolute value, meaning without regard to the sign of the change)
when the market discount rate goes down than when it goes up (the convexity effect).
B. Incorrect because for the same coupon rate and time-to-maturity, the percentage price
change is greater (in absolute value, meaning without regard to the sign of the change)
when the market discount rate goes down than when it goes up (the convexity effect).
C. Correct because for the same coupon rate and time-to-maturity, the percentage price
change is greater (in absolute value, meaning without regard to the sign of the change)
when the market discount rate goes down than when it goes up (the convexity effect)
Fixed Income: identify the relationships among a bond's price, coupon rate, maturity, and
yield-to-maturity

37.
A. Incorrect because the opposite is true due to the convexity effect. For the same coupon
rate and time-to-maturity, the percentage price change is greater (in absolute value,
meaning without regard to the sign of the change) when the market discount rate goes
down than when it goes up (the convexity effect).
B. Incorrect because it ignores the convexity effect of most option-free bonds. For the same
coupon rate and time. to-maturity, the percentage price change is greater (in absolute
value, meaning without regard to the sign of the change) when the market discount rate
goes down than when it goes up (the convexity effect).
C. Correct because for the same coupon rate and time-to-maturity, the percentage price
change is greater (in absolute value, meaning without regard to the sign of the change)
when the market discount rate goes down than when it goes up (the convexity effect).
Fixed Income: identify the relationships among a bond's price, coupon rate, maturity, and
yield-to-maturity

15
CFA Program Level I for February 2024

38.
A. Incorrect because for the same time-to-maturity, a lower-coupon bond has a greater
percentage price change than a higher-coupon bond when their market discount rates
change by the same amount (the coupon effect). Bond 1 has the same time-to-maturity as
Bond 3 but a higher coupon, thus Bond 1 would experience a smaller percentage price
change compared to Bond 3.
B. Incorrect because generally, for the same coupon rate, a longer-term bond has a greater
percentage price change than a shorter-term bond when their market discount rates change
by the same amount (the maturity effect). Bond 2 has the same coupon rate as Bond 3 but a
shorter maturity, thus Bond 2 would experience a smaller percentage price change
compared to Bond 3.
C. Correct because for the same time-to-maturity, a lower-coupon bond has a greater
percentage price change than a higher-coupon bond when their market discount rates
change by the same amount (the coupon effect). Bond 3 has the same time-to-maturity as
Bond 1 but a lower coupon, thus Bond 3 would experience a greater percentage price
change compared to Bond 1. Also, generally, for the same coupon rate, a longer-term bond
has a greater percentage price change than a shorter-term bond when their market
discount rates change by the same amount (the maturity effect). Bond 3 has the same
coupon rate as Bond 2 but a longer maturity, thus Bond 3 would experience a greater
percentage price change compared to Bond 2.
Fixed Income: identify the relationships among a bond's price, coupon rate, maturity, and
yield-to-maturity

39.
A. Incorrect because the spot curve can be calculated as the geometric average of the
forward rates.
B. Correct because implied forward rates (also known as forward yields) are calculated from
spot rates. An implied forward rate is a break-even reinvestment rate. When the market is
in equilibrium (no arbitrage) the implied forward rate is the same as the forward rate.
C. Incorrect because spot rates are yields-to-maturity on zero-coupon bonds maturing at the
date of each cash flow.
Fixed Income: define spot rates and the spot curve, and calculate the price of a bond using
spot rates

16
CFA Program Level I for February 2024

40.
A. Incorrect because bonds with embedded options have well-defined effective convexity.
Negative convexity, which could be called "concavity," is an important feature of callable
bonds. Putable bonds, on the other hand, always have positive convexity.
B. Correct because in brief, a callable bond does not have a well-defined internal rate of
return (yield-to-maturity). Therefore, yield duration statistics, such as modified and
Macaulay durations, do not apply; effective duration is the appropriate duration measure.
C. Incorrect because effective duration is a curve duration statistic in that it measures
interest rate risk in terms of a parallel shift in the benchmark yield curve (𝛥Curve). The
interest rate risk of bonds with embedded options is most appropriately measured using
effective duration, a curve statistic, which means that the sensitivity of a bond with an
embedded-option to a change in the level of the benchmark yield curve is in fact well-
defined.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

41.
A. Correct because extension risk is the risk that when interest rates rise, prepayments will
be lower than forecasted because homeowners are reluctant to give up the benefits of a
contractual interest rate that now looks low. As a result, a security backed by mortgages will
typically have a longer maturity than was anticipated at the time of purchase.
B. Incorrect because contraction risk is the risk that when interest rates decline, actual
prepayments will be higher than forecasted because homeowners will refinance at now-
available lower interest rates. Thus, a security backed by mortgages will have a shorter
maturity than was anticipated at the time of purchase. Holding a security whose maturity
becomes shorter when interest rates decline has two adverse consequences for investors.
First, investors must reinvest the proceeds at lower interest rates. Second, if the security is
prepayable or callable, its price appreciation is not as great as that of an otherwise identical
bond that does not have a prepayment or call option. Increased contraction risk occurs
when interest rates decline, not increase.
C. Incorrect because contraction risk is the risk that when interest rates decline, actual
prepayments will be higher than forecasted because homeowners will refinance at now-
available lower interest rates. First, investors must reinvest the proceeds at lower interest
rates. When interest rates decline, as opposed to increase, prepayments are likely to
increase and be reinvested at lower rates, thus increasing reinvestment risk. This is not likely
to occur when interest rates rise.
Fixed Income: define prepayment risk and describe time tranching structures in
securitizations and their purpose

17
CFA Program Level I for February 2024

42.
A. Incorrect because yield spreads widen based on two primary factors: (1) a decline in an
issuer's creditworthiness, sometimes referred to as credit migration or downgrade risk, and
(2) an increase in market liquidity risk.
B. Correct because in periods of high demand for bonds, spreads will move tighter.
C. Incorrect because yield spreads widen based on two primary factors: (1) a decline in an
issuer's creditworthiness, sometimes referred to as credit migration or downgrade risk, and
(2) an increase in market liquidity risk. Most markets beads trade primarily over the counter
through broker-dealers trading for ther own accounts Their ability and willingness to make
markets, as reflected in the bid-ask spread, is an important determinant of market liquidity
risk.
Fixed Income: describe macroeconomic, market, and issuer-specific factors that influence
the level and volatility of yield spreads

43.
A. Incorrect because each repo contract participant is exposed to the risk that the other
party is unable to meet its obligations
B. Incorrect because each repo contract participant is exposed to the risk that the other
party is unable to meet its obligations, regardless of the quality of the collateral used in the
repo transaction. The collateral should have little or no correlation with the credit risk of the
repo counterparty in order to diversify credit exposure.
C. Correct because in addition to the high quality of underlying securities, repos include
features designed to reduce the risk of a collateral shortfall over the contract life. One such
feature is the provision of collateral in excess of the cash exchanged, known as initial
margin.
Fixed Income: describe repurchase agreements (repos), their uses, and their benefits and
risks

44.
A. Correct because for parallel shifts in the benchmark yield curve, key rate durations will
indicate the same interest rate sensitivity as effective duration.
B. Incorrect because the difference between approximate modified duration and effective
duration is in the denominator. Modified duration is a >yield duration statistic in that it
measures interest rate risk in terms of a change in the band's own yield-to-maturity (AYield).

18
CFA Program Level I for February 2024

This question refers to changes in the benchmark yield curve, not the bond's own yield to
maturity, therefore, modified duration is an incorrect measure.
C. Incorrect because the difference between approximate modified duration and effective
duration is in the denominator. Modified duration is a yield duration statistic in that it
measures interest rate risk in terms of a change in the band's own yield-to-maturity (AYield)
Additionally, The calculation of the modified duration (ModDur) statistic of a bond requires
a simple adjustment to Macaulay duration. It is the Macaulay duration statistic divided by
one plus the yield per period. Thus, the Macaulay duration, as a mathematical derivative of
modified duration, is also a measure of risk in terms of the change in a bond's own yield-to-
maturity. This question refers to changes in the benchmark yield curve, not the bond's own
yield-to-maturity, therefore, modified duration is an incorrect measure.
Fixed Income: define key rate duration and describe its use to measure price sensitivity of
fixed-income instruments to benchmark yield curve changes

45.
A. Incorrect because the creation of bond classes that possess different expected maturities
is referred to as time a form of credit tranching, not time tranching.
B. Correct because it is common for securitizations to include a form of internal credit
enhancement called Subordination is subordination, also referred to as credit tranching. In
such a structure, there is more than one bond class or tranche, and the bond classes differ
as to how they will share any losses resulting from defaults of the borrowers whose loans
are in the collateral. The bond classes are classified as senior bond classes or subordinated
bond classes hence, the reason this structure is also referred to as a senior/subordinated
structure.
C. Incorrect because prepayment risk is the uncertainty that the cash flows will be different
from the scheduled cash flows as set forth in the loan agreement because of the borrowers'
ability to alter payments. This risk is related to time tranching, not credit tranching.
Fixed Income: describe typical credit enhancement structures used in securitizations

46.
A. Incorrect because a callable bond does not have a well-defined internal rate of return
(yield-to-maturity). Therefore, yield duration statistics, such as modified and Macaulay
durations, do not apply effective duration is the appropriate duration measure
B. Correct because modified duration can be used to measure the interest rate risk of a non-
complex bond such as a US Treasury bond, while effective duration is essential to the
measurement of the interest rate risk of a complex bond, such as a bond that contains an
embedded call option.

19
CFA Program Level I for February 2024

C. Incorrect because another fixed-income security for which yield duration statistics, such
as modified and Macaulay durations, are not relevant is a mortgage-backed bond.
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

47.
A. Incorrect because the effective duration of a bond is the sensitivity of the bond's price to
a change in a benchmark yield curve, not to a change in the bond's yield to maturity
B. Correct because modified duration is a yield duration statistic in that it measures interest
rate risk in terms of a change in the bond's own yield-to-maturity. Modified duration
provides an estimate of the percentage price change for a bond given a change in its yield-
to-maturity
C. Incorrect because Macaulay duration is a weighted average of the time to receipt of the
bond's promised payments, where the weights are the shares of the full price that
correspond to each of the bond's promised future payments.
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

48.
A. Incorrect because it calculates modified duration using the coupon rather than YTM.
MacDur / (1 + coupon) = 10/1.06 = 9.43.
B. Correct because modified duration provides an estimate of the percentage price change
for a bond given a change in its yield-to-maturity [YTM]
Modified duration = Macaulay Duration / (1+r) = 10.0 / 1.045 = 9.5694
%*SYMBOL*PV ≈ - AnnModDur x 𝛥Yield = - 9.5694 x -1% = 9.5694% ≈ 9.57%.
C. Incorrect because this is Macaulay duration. Macaulay duration must be adjusted by the
yield-to-maturity to calculate the modified duration, and afterwards, modified duration is
the used to calculate the percentage price change for a change in bond's yield to maturity.
Fixed Income: calculate the percentage price change of a bond for a specified change in
yield, given the bond's duration and convexity

49.
A. Incorrect because affirmative covenants are typically administrative in nature. For
example, frequently used affirmative covenants include what the issuer will do with the

20
CFA Program Level I for February 2024

proceeds from the bond issue and the promise of making the contractual payments. The
issuer may also promise to comply with all laws and regulations.
B. Correct because negative pledges prevent the issuance of debt that would be senior to or
rank in priority ahead of the existing bondholders ' debt. This is a negative covenant.
C. Incorrect because affirmative covenants are typically administrative in nature. For
example, a pari passu (or"equal footing") clause, which ensures that a debt obligation is
treated the same as the borrower's other senior debt instruments.
Fixed Income: describe the contents of a bond indenture and contrast affirmative and
negative covenants

50.
A. Incorrect because it determines ApproxModDur but then adjusts the calculated duration
measure by dividing it by (1 + r), instead of multiplying.
AppxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 × ( 𝛥𝑌𝑖𝑒𝑙𝑑) × (𝑃𝑉0 )] = (100.45-99.56)/(2 x 0.001 x
100) = 4.45. ApproxMacDur ≠ ApproxModDur / (1+r) = 4.45/(1+0.04) = 4.279 ≈ 4.28.
B. Incorrect because it does not further adjust the modified duration to determine the
Macaulay duration. AppxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 × ( 𝛥𝑌𝑖𝑒𝑙𝑑) × (𝑃𝑉0 )] = (100.45-
99.56)/(2 x 0.001 x 100) = 4.45.
C. Correct because it adjusts the Approximate Modified Duration by 1+ yield to maturity to
determine the Macaulay duration. AppxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 × ( 𝛥𝑌𝑖𝑒𝑙𝑑) ×
(𝑃𝑉0 )] = (100.45-99.56)/(2 x 0.001 x 100) = 4.45. Macaulay duration = modified duration x (1
+ YTM) = 4.45 x (1 + 0.04) = 4.628 ≈ 4.63.
Fixed Income: define, calculate, and interpret Macaulay duration

51.
A. Incorrect because this is net income plus depreciation & amortization divided by interest
expense.
Interest coverage ≠ (85 + 15) / 15= $100 / 15 = 6.7, rounded to 7.
B. Correct because operating income is defined as operating revenues minus operating
expenses and is commonly referred to as 'earnings before interest and taxes' (EBIT).
Interest coverage using EBIT is operating income/interest expense. = $120/15 = 8.
C. Incorrect because this is interest coverage using EBIT plus depreciation & amortization
(EBITDA. not EBIT) divided by interest expense.
Interest coverage ≠ ($120 + $15) / 15 = 9.
Fixed Income: calculate and interpret financial ratios used in credit analysis

21
CFA Program Level I for February 2024

52.
A. Correct because key rate duration (or partial duration) is a measure of a bond's sensitivity
to a change in the benchmark yield curve at a specific maturity segment. In contrast to
effective duration, key rate durations help identify 'shaping risk for a bond-that is, a bond's
sensitivity to changes in the shape of the benchmark yield curve (e.g., the yield curve
becoming steeper or flatter).
B. Incorrect because effective duration indicates the bond's sensitivity to the benchmark
yield curve assuming that all yields change by the same amount. In contrast to effective
duration, key rate durations help identify shaping risk' for a band that is, a band's sensitivity
to changes in the shape of the benchmark yield curve (e g., the yield curve becoming
steeper or flatter).
C. Incorrect because yield duration statistics measuring the sensitivity of a bond's full price
to the bond's own yield- to-maturity include the Macaulay duration, modified duration,
money duration, and price value of a basis point. The Macaulay duration measures the
sensitivity of a bond's full price to a change in its yield to maturity, not to changes in the
shape of the benchmark yield curve.
Fixed Income: define key rate duration and describe its use to measure price sensitivity of
fixed-income instruments to benchmark yield curve changes

53.
A. Correct because market liquidity risk is the risk that the price at which investors can
actually transact-buying or selling-may differ from the price indicated in the market. The
lower the quality of the issuer, the higher the market liquidity risk
B. Incorrect because the lower the quality of the issuer, the higher the market liquidity risk.
In this case the investment grade borrower has less market liquidity risk, not the same.
C. Incorrect because the lower the quality of the issuer, the higher the market liquidity risk.
In this case the investment grade borrower has less market liquidity risk, not more.
Fixed Income: describe credit risk and its components, probability of default and loss given
default

54.
A. Correct because modified duration provides an estimate of the percentage price change
for a bond given a change in its yield-to-maturity. A modified duration of 2.4 tranlates to a
2.4% percentage price change given a 100 basis points change in the bond's yield to
maturity. Therefore, for a 50 basis point decrease in yields, the bond's price will change by
(2.4)(0.0050)($912,575) = $10.951 ≈ $11,000.

22
CFA Program Level I for February 2024

B. Incorrect because it uses an incorrect calculation ( 0.024)($912,575) = $21,902 ≈ $22,000.

C. Incorrect because it uses an incorrect calculation (0.024)($1,000,000) = $24,000.
Fixed Income: calculate the percentage price change of a bond for a specified change in
yield, given the bond's duration and convexity

55.
A. Correct because modified duration provides anestimate of the percentage price change
for a bond given a change in its yield-to-maturity: %𝛥𝑃𝑉 𝐹𝑢𝑙𝑙 ≈ -AnnModDur x 𝛥Yield. Also,
another version of money duration is the price value of a basis point (PVBP) for the bond.
The PVBP is an estimate of the change in the full price given a 1 bp change in the yield-to-
maturity Here: -6.2 x 0.0001 0.00062 and PVBP = 0.00062 x 103.50 = 0.06417, rounded to
0.0642.
B. Incorrect because it represents a 10 bp change in rates, not 1 bp: -6.2 x 0.001 = 0.0062
and PVBP ≠ 0.0062 × 103.50 = 0.6417, rounded to 0.642.
C. Incorrect because it represents a 1 percent change in rates (100 bp), not 1 bp: -6.2 x 0.01
= 0.062 and PVBP ≠ 0.062 × 103.50 = 6.417, rounded to 6.42
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

56.
A. Correct because money duration (Money Dur) is calculated as the annual modified
duration times the full price (𝑃𝑉 𝐹𝑢𝑙𝑙 ) of the bond, including accrued interest. Thus the
modified durations of the bands are 730/95 = 7.6842 and 515/120 = 4.29167, respectively.
The modified duration of a bond portfolio is calculated as the weighted average of the
statistics for the individual bonds. The shares of overall portfolio market value are the
weights. Here, the market values of the bonds are £25 million * 95/100 = £23,750,000 and
£25 million* 120/100 = £30,000,000. Thus the weight of the first bond in the portfolio is
£23,750,000/(£23,750,000+ £30,000,000) = 44.186% and the weight of the second bond in
the portfolio is £30,000,000/(£23,750,000+ £30,000,000) = 55.814%. The modified duration
of the portfolio is therefore 44.186% * 7.6842 + 55.814% * 4.29167 = 3.3953 +2.3953 =
5.7907, rounded to 5.8.
B. Incorrect because the modified duration of the portfolio is not equal to the weighted
average of the money durations of the bonds divided by 100. Portfolio modified duration <>
44.186% * 730/100 + 55.814% 5.15/100 = 6.1. Instead, the modified duration of a bond
portfolio is calculated as the weighted average of the statistics for the individual bonds. The
shares of overall portfolio market value are the weights.

23
CFA Program Level I for February 2024

C. Incorrect because the modified duration of the portfolio is not equal to the simple
average of the money durations of the bonds divided by 100. Portfolio modified duration <>
50% * 730/100 + 50% * 5.15/100 = 6.225, rounded to 6.2. Instead, the modified duration of
a bond portfolio is calculated as the weighted average of the statistics for the individual
bonds. The shares of overall portfolio market value are the weights. Candidates may choose
this option because the par values of the bonds are the same.
Fixed Income: calculate portfolio duration and convexity and explain the limitations of these
measures

57.
A. Incorrect because as a general rule , the higher the senior unsecured rating, the smaller
the notching adjustment.
B. Incorrect because notching is applied according to each credit rating agency's notching
guidelines
C. Correct because recognizing different payment priorities, and thus the potential for
higher (or lower) loss severity in the event of default, the rating agencies have adopted a
notching process whereby their credit ratings on issues can be moved up or down from the
issuer rating which is usually the rating applied to its senior unsecured debt. As a general
rule, the higher the senior orisecured rating, the smaller fne notching adjustment. The
reason behind this is that the higher the rating, the lower the perceived risk of default so,
the need to 'notch' the rating to capture the potential difference in loss seventy is greatly
reduced. For lower rated credits, however, the risk of default is greater and thus be potensa
diterence in foss from a lower (or higher angray ranking is a bager consideration in assessing
an issue's credit riskiness
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

58.
A. Incorrect because per capita income is a concern for sovereign bonds or general
obligation bonds, not non- sovereign govemment revenue bonds. Income per capita: More
prosperous countries generally have a broader and deeper tax base with which to support
debt. The economic analysis of non-sovereign government GO bonds, including US
municipal bonds, focuses on employment, per capita income (and changes in it over time),
per capita debt (and changes in it over time), the tax base (depth, breadth, diversification,
stability, etc.)
B. Incorrect because the tax base is a concern for sovereign bonds or general obligation
bonds. Income per capita: More prosperous countries generally have a broader and deeper
tax base with which to support debt. The economic analysis of non-sovereign government

24
CFA Program Level I for February 2024

GO bonds, including US municipal bonds, focuses on employment, per capita income (and
changes in it over time), per capita debt (and changes in it over time), the tax base (depth,
breadth, diversification, stability, etc.).
C. Correct because revenue bonds are issued for specific project financing (eg, financing for
a new sewer system, a toll road, bridge, hospital, a sports arena, etc.). Revenue bonds,
which are issued to finance a specific project, have a higher degree of risk than GO bonds
because they are dependent on a single source of revenue. A key credit measure for
revenue-backed non-sovereign government bonds is the debt-service-coverage (DSC) ratio,
which measures how much revenue is available to cover debt payments (principal and
interest) after operating expenses.
Fixed Income: explain special considerations when evaluating the credit of sovereign and
non-sovereign government debt issuers and issues

59.
A. Incorrect because it is the 1y2y implied forward yield. The yield can be found using (1 +
z)1 x (1+ IFR1,2)²= (1 + Z3)³; (1+0.015)¹× (1+IFR1,2)²= (1+0.035)³× (1+ IFR1,2)² = (1 +
0.035)/(1+0.015) - 1 = 1.1087/1.0150 = 1.0923. IFR1,2 = 1.0923 -1 = 0.0451 or 4.51%.
B. Correct because the 2y1y yield is the implied one-year forward yield two years from now.
The 2y1y implied yield can be found using (1+ z1)(1+ z2) x (1+ IFR2,1)=(1+z3)3= (1+0.015) x
(1+0.025) x (1+ IFR1,2) = (1+1.035)³. (1 + IFR1, 2)² = (1 +1.040)3/[(1+0.015) x (1.025)] - 1 =
1.1087/1.0404 = 1.0656 - 1 = 0.0656 or 6.6%.
C. Incorrect because it is the compounded three year to maturity bond divided by the
product of the first two yields to maturity. The yield is found as (1 + z₁) × (1+ z₂) ×(1 + IFR 1,2)
= (1+z3)3 = (1 + 0.015) × (1 + 0.025) × (1+ IFR₁,₂) = (1 +1.035)3. (1 + IFR1, 2)²= (1 +
1.040)3/[(1+0.015) x (1.025)] - 1 = 1.1087/1.0404 = 1.0656 - 1 = 0.0656 or 6.6%
Fixed Income: define par and forward rates, and calculate par rates, forward rates from spot
rates, spot rates from forward rates, and the price of a bond using forward rates

60.
A. Correct because some fixed-rate bonds are not actively traded. Therefore, there is no
market price available to calculate the rate of return required by investors. In these
situations, it is common to estimate the market discount rate and price based on the quoted
or flat prices of more frequently traded comparable bonds. These comparable bonds have
similar fimes-to-maturity coupon rates, and credit quality. This estimation process is called
matrix pricing The estimated market discount rate can be obtained with linear interpolation.
Using linear interpolation between the two given bonds, we have: 0.034+ (5 - 3) / (8 - 3) x
(0064 - 0034) = 0.034+ 2/5 x 0.02=0.042 = 4.2%

25
CFA Program Level I for February 2024

B. Incorrect because the simple average is used instead of linear interpolation in matrix
pricing. Some fixed-rate bonds are not actively traded. Therefore, there is no market price
available to calculate the rate of return required by investors. In these situations, it is
common to estimate the market discount rate and price based on the quoted or flat prices
of more frequently traded comparable bonds. These comparable bonds have similar times-
to- maturity, coupon rates, and credit quality. This estimation process is called matrix
pricing. The estimated market discount rate can be obtained with linear interpolation. Using
the simple average of the two given bonds, we have (0.034 +0.054)/2=0.088/2= 0.044=4.4%.
C. Incorrect because the finear interpolation dar matrix pricing is implemented from the
wrong end of the interval. Some fixed-rate bonds are not actively traded. Therefore, there is
no market price available to calculate the rate of retum required by investors. In these
situations, it is common to estimate the market discount rate and price based on the quoted
or flat prices of more frequently traded comparable bonds. These comparable bonds have
similar tires-to-isafunty cannon cales and credit quality. This estimation amoess is called
eratrix pricing. The es bmete fatkebdisonart inte can be cofeined with linear intereation.
Usitig meat inlatbotolica firm the wraite end between the two given bonds, we have: 0.034+
(8-5)/(8-3) * (0.054 -0.034) = 0.034 +3/5x0.02 = 0.046 = 4.6%.
Fixed Income: describe matrix pricing

61.
A. Incorrect because the put provision is a valuable option for the bondholders, therefore
putable bonds offer a lower yield (and thus have a higher price) than otherwise similar non-
putable bonds.
B. Correct because the call provision is a valuable option for the issuer. Thus, other things
equal, investors require a higher yield (and thus pay a lower price) for a callable bond than
for an otherwise similar non-callable bond.
C. Incorrect because a convertible bond gives the bondholder the right to convert the bond
into common shares of the issuing company. Because this option favors the bondholder,
convertible bonds offer a lower yield and sell at a higher price than otherwise similar non-
convertible bonds.
Fixed Income: describe common cash flow structures of fixed-income instruments and
contrast cash flow contingency provisions that benefit issuers and investors

62.
A. Incorrect because the currency denomination of a bond's cash flows influences which
country's interest rates affect a bond's price. The price of a bond issued by a US-based
company and denominated in British pounds will be affected by British interest rates.

26
CFA Program Level I for February 2024

B. Correct because the currency denomination of a bond's cash flows influences which
country's interest rates affect a bond's price. The price of a bond issued by a US-based
company and denominated in British pounds will be affected by British interest rates.
C. Incorrect because the currency denomination of a bond's cash flows influences which
country's interest rates affect a bond's price. The price of a bond issued by a US-based
company and denominated in British pounds will be affected by British interest rates.
Fixed Income: describe how legal, regulatory, and tax considerations affect the issuance and
trading of fixed-income securities

63.
A. Correct because the applicable interest rate in December is the six-month market
reference rate in June plus the 45 basis point margin = 1.95% +0.45% = 2.40%.
B. Incorrect because the 45 bps margin is added to the average of the June and December
six-month market reference rates = (2.25% + 1.95% )/2+0.45% = 2.55%.
C. Incorrect because the 45 bps margin is added to the market reference rate in December =
2.25% +0.45% = 2.70%
Fixed Income: calculate and interpret yield spread measures for floating-rate instruments

64.
A. Correct because the approximate modified duration of a bond is calculated as follows:
ApproxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 ∗ ( 𝛥𝑌𝑖𝑒𝑙𝑑) ∗ (𝑃𝑉0 )]
= (103.40 - 100.95)/(2 x 0.0070 x 101.80)
= 2.45/1.4252 = 1.7191 ≈ 1.72.
B. Incorrect because the approximate modified duration of a bond is calculated as follows
ApproxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 ∗ ( 𝛥𝑌𝑖𝑒𝑙𝑑) ∗ (𝑃𝑉0 )]
However, in this case, the higher yield/lower price is omitted from the calculation and the
multiplication by 2 in the denominator is omitted as well: = (103.40 -
101.80)/(101.80*(6.75% - 6.05%)) = 2.2453 = 2.25.
C. Incorrect because the approximate modified duration of a bond is calculated as follows
ApproxModDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 ∗ ( 𝛥𝑌𝑖𝑒𝑙𝑑) ∗ (𝑃𝑉0 )]
However, in this case, the number 2 is omitted from the denominator.
= (103.40-100.95)/(0.0070 × 101.80)
= 2.45/0.7126 = 3.4381 ≈ 3,44.
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

27
CFA Program Level I for February 2024

65.
A. Incorrect because the effective duration is incorrectly calculated as
EffDur = [(𝑃𝑉0 ) − (𝑃𝑉+ )]/[( 𝛥𝐶𝑢𝑟𝑣𝑒) ∗ (𝑃𝑉0 )] = (95.35-92.25)/(0.005 × 95.35) = 6.50.
B. Correct because the effective duration of a bond is the sensitivity of the bond's price to a
change in a benchmark yield curve.
EffDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[2 ∗ ( 𝛥𝐶𝑢𝑟𝑣𝑒) ∗ (𝑃𝑉0 )]
With 𝑃𝑉0 = 95.35, 𝑃𝑉− = 99.50, 𝑃𝑉+ = 92.25,
EffDur= (99.50 - 92.25)/(2 x 0.005 x 95,35) = 7.60
C. Incorrect because the effective duration is incorrectly calculated as
EffDur = [(𝑃𝑉− ) − (𝑃𝑉+ )]/[( 𝛥𝐶𝑢𝑟𝑣𝑒) ∗ (𝑃𝑉0 )] = (99.50 - 95.35)/(0.005 x 95.35) = 8.70
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

66.
A. Incorrect because 4.75% is used as the coupon rate and 5.50% as the reinvestment rate,
resulting in (4.75 x 1.0550^2) + (4.75 x 1.0550) + 4.75 = 15.0481 ≈ 15.05.
Interest rates are the rates at which coupon payments are reinvested and the market
discount rates at the time of purchase and at the time of sale if the bond is not held to
maturity.
B. Correct because the first coupon is reinvested at 4.75% for two years, the second coupon
is reinvested at 4.75% for one year, and the third coupon has not yet been reinvested.
(5.50 × 1.0475^2)+(5.50×1.0475) + 5.50 = 17 2962 ≈ 17 30.
Interest rates are the rates at which coupon payments are reinvested and the market
discount rates at the time of purchase and at the time of sale if the bond is not held to
maturity.
C. Incorrect because the coupons are deemed to have been reinvested over 3 years, 2 years,
and 1 year, respectively, resulting in (5.50 x 1.0475^3)+(5.50 x 1.0475 ^2)+(5.50 x 1.0475) =
18.1177 ≈ 18.12.
Interest rates are the rates at which coupon payments are reinvested and the market
discount rates at the time of purchase and at the time of sale if the bond is not held to
maturity.
Fixed Income: calculate and interpret the sources of return from investing in a fixed-rate
bond;

28
CFA Program Level I for February 2024

67.
A. Incorrect because the flat price usually is quoted by bond dealers. If a trade takes place,
the accrued interest is added to the flat price to obtain the full price paid by the buyer and
received by the seller on the settlement date.
B. Correct because the flat price usually is quoted by bond dealers. If a trade takes place,
the accrued interest is added to the flat price to obtain the full price paid by the buyer and
received by the seller on the settlement date.
C. Incorrect because the flat price usually is quoted by bond dealers. If a trade takes place,
the accrued interest is added to the flat price to obtain the full price paid by the buyer and
received by the seller on the settlement date" and the full price also is called the invoice or
'dirty' price.
Fixed Income: calculate a bond's price given a yield-to-maturity on or between coupon
dates

68.
A. Incorrect because it is the flat price that is affected by a market discount rate change
B. Incorrect because it is the flat price that is affected by a market discount rate change, and
if the flat price is affected by the market discount rate so is the full price (as full price equals
flat price plus accrued interest).
C. Correct because the accrued interest part of the full price does not depend on the yield-
to-maturity.
Fixed Income: calculate a bond's price given a yield-to-maturity on or between coupon
dates

69.
A. Incorrect because it uses 100 bps instead of 75bps in the denominator
Duration ≠ 108.5 - 104
2 × 106 x 0.0100 ≠ 2.12, or 2.1
B. Correct because the following formula estimates the approximate percentage price
change for a 100 basis point change in yield (duration) is
Duration = Price if yield declines - Price if yield rises
2 x (initial price) x (change in yield in decimal format)
= 108.5 - 104
2 x 106 x 0.0075

29
CFA Program Level I for February 2024

= 4.5
1.59
= 2.83, or 2.8
C. Incorrect because it uses par value instead of market value in the denominator
Duration ≠ 108.5 - 104
2 x 100 x 0.0075 ≠ 3.0
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

70.
A. Correct because the conversion ratio is the number of common shares that each bond
can be converted into.
B. Incorrect because the conversion price is the price per share at which the convertible
bond can be converted into shares.
C. Incorrect because the conversion value, sometimes called the parity value, is the current
share price multiplied by the conversion ratio.
Fixed Income: describe common cash flow structures of fixed-income instruments and
contrast cash flow contingency provisions that benefit issuers and investors

71.
A. Incorrect because a non-amortizing loan does not involve scheduled principal
repayments, an ABS backed by non-amortizing loans is not affected by prepayment risk.
Credit card receivable ABS are an example of ABS backed by non-amortizing loans
B. Incorrect because a non-amortizing loan does not involve scheduled principal
repayments, an ABS backed by non-amortizing loans is not affected by prepayment risk.
Credit card receivable ABS are an example of ABS backed by non-amortizing loans.
C. Correct because the collateral of credit card receivable ABS is a pool of non-amortizing
loans. These loans have lockout periods during which the cash flows that are paid out to
security holders are based only on finance charges collected and fees. When the lockout
period is over, the principal that is repaid by the cardholders is no longer reinvested but
instead is distributed to investors.
Fixed Income: describe types and characteristics of non-mortgage asset-backed securities,
including the cash flows and risks of each type

30
CFA Program Level I for February 2024

72.
A. Incorrect because it omits the basis point change x 100 from the calculation.
Effective duration ≠ (𝑃𝑉− ) − (𝑃𝑉+ )/2 = (103 - 98)/2 = 2.5
B. Incorrect because it is the difference in the prices (103-98 = 5).
C. Correct because the effective duration is calculated as (𝑃𝑉− ) − (𝑃𝑉+ )]/[2 ∗ ( 𝛥𝐶𝑢𝑟𝑣𝑒) ∗
𝑃𝑉0 ) where: 𝑃𝑉+ = the bond price when the benchmark yield is decreased, 𝑃𝑉0 = the bond
price when the benchmark yield is increased, and PV, then current bond price.
Effective duration = (103-98)/(2 * 0.0025 × 100) = 10.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

73.
A. Correct because the general formula for the relationship between two spot rates and the
implied forward rate is (1 + 𝑍𝐴 ) 𝐴 * (1 + 𝐼𝐹𝑅𝐴.𝐵−𝐴 )𝐵−𝐴 = (1 + 𝑍𝐵 )𝐵𝑛 where z, is the x-
year spot rate and IFR is the y-year forward rate, x years from now. Using the formula, the 6
year spot rate can be calculated in two different ways:
X
1. Using A = 2, B=6 : (1 + z6)6 = (1 + z2)2 × (1+ IFR2,4)4
2. Using A = 4, B = 6: (1 + z6)6 = (1 + Z4) × (1+IFR4,2)2
Equating the two we get: (1+z2)2 x (1 + IFR2,4)4 = (1 + z4)4 × (1+ IFR4,2)2. Using the numbers
from the stem:
(1+0.01)2 × (1+0.03)4=(1+0.025)4 × (1+IFR4,2)4
1.0201 x 1.1255 = 1.1038 × (1+ IFR4,2)2
IFR4,2 =(1.1481/1.1038)0.5-1=0.0199~2%.

B. Incorrect because instead of using the formula for the relationship between spot rates
and the implied forward rates, the candidate assumed that the 2 year forward rate, 4 years
from today is equal to the 4 year forward rate, 2 years from today.
C. Incorrect because when calculating IFR in the last step, the candidate forgets to take the
square root IFR4,2 ≠1.1481/1.1038-1 = 0.0401 ≈ 4%.
Fixed Income: define par and forward rates, and calculate par rates, forward rates from spot
rates, spot rates from forward rates, and the price of a bond using forward rates

31
CFA Program Level I for February 2024

74.
A. Incorrect because as noted in the rationale for the correct answer, the issuer credit rating
usually applies to senior unsecured debt.
B. Correct because the issuer credit rating usually applies to its senior unsecured debt.
C. Incorrect because as noted in the rationale for the correct answer, the issuer credit rating
usually applies to senior unsecured debt.
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

75.
A. Incorrect because the convexity adjustment is subtracted rather than added. The
percentage change in price is not equal to -4.901961*-0.01- (0.5 * 28.835* -
0.014)=0.04901961 -0.0014418 = 4.757781%, rounded to 4.76%.
B. Correct because the Macaulay duration of a zero-coupon bond is its time-to-maturity and
modified duration is the Macaulay duration statistic divided by one plus the yield per period
Here, modified duration = 5 / 1.02 = 4.901961
Thus, the percentage change in price = -4.901961* -0.01 + (0.5*28.835* -0.012) =
0.04901961 + 0.0014418 = 5.04614%, rounded to 5.05%.
C. Incorrect because the convexity adjustment is applied to the Macaulay duration rather
than the modified duration. The percentage change in price is not equal to -5* -0.01+
(0.5*28.835 - 0.012) = 0.05 +0.0014418 = 5.14418%, rounded to 5.14%.
Fixed Income: calculate the percentage price change of a bond for a specified change in
yield, given the bond's duration and Convexity

76.
A. Incorrect because the Macaulay duration of a zero-coupon bond is equal to the time-to-
maturity, not less-than the time-to-maturity.
B. Correct because the Macaulay duration of a zero-coupon bond is its time-to-maturity.
C. Incorrect because the Macaulay duration of a zero-coupon bond is equal to the time-to-
maturity, not greater-than the time-to-maturity.
Fixed Income: define, calculate, and interpret Macaulay duration

32
CFA Program Level I for February 2024

77.
A. Incorrect because government agencies are quasi-government entities that issue debt in
order to fund the government-sponsored provision of specific public goods or services
based on sovereign or local law This may involve the financing of specific activities
promoted by the govemment or the operation of necessary infrastructure as mandated by
law The bonds issued by these agencies are known as quasi govemment bonds or agency
bonds
B. Correct because the main types of non-sovereign government issuers include agencies,
public banks supranationals and regional governments Redicinal Governrsent testers. These
inchide provincial, state, ama incal governams, referred to as muiticpal bouds in the US and
most often as local authority bonds elsewhere within a specias sovereign Junsdiction
C. Incorrect because government agencies are quas-government entities that issue debt in
order to fund the government-sponsored provisies of specific public goods or senecue based
on sovereign or local law. This may involve the financing of snet 50 aervities promoter by
the emernout the asennon of necessary lottastover, its mamfered by lass Timi coals relied
by these agences are asoen as quest bouddment biheds or neary bonds
Fixed Income: desenterfinding choices by sovereign and monisovereige governments, quasi-
govamenteobusa and supranational agencies

78.
A. Correct because the Macaulay and modified durations for the portfolio are calculated as
the weighted average of the statistics for the individual bonds. The shares of overall
portfolio market value are the weights.
First we calculate the modified duration (ModDur) of the individual bonds using formula
below
ModDur = MacDur / (1+r)
ModDur of Bond 1 = 7.5/(1+4%) = 7.211538
ModDur of Bond 2 = 5.4/(1+3%) = 5.242718.
Next, we calculate the weights for the individual bonds based on market values, as follows:
Weight for Bond 1 = $200,000 / ($200,000 + $400,000) = 0.333333
Weight for Bond 2 = $400,000 / ($200,000 + $400,000) = 0.666667
Modified duration of the portfolio = (Weight for Bond 1 x ModDur of Bond 1) + (Weight for
Bond 2 x ModDur of Bond 2) = (0.333333 7.211538) + (0.666667 x 5.242718)= 5.898992 ≈
5.9.
B. Incorrect because the weights based on par value are used.
Weight for Bond 1≠ $300,000/ ($300,000+ $450,000) = 0.4
Weight for Bond 2≠ $450,000/ ($300,000+ $450,000) = 0.6
Modified duration of the portfolio (0.4 x 7.211538) + (0.6 x 5.242718)=6.030246 ≈ 6.0.

33
CFA Program Level I for February 2024

C. Incorrect because it uses Macaulay duration instead of modified duration for the
individual bonds, and represents the Macaulay duration of the portfolio.
Modified duration of the portfolio Macaulay duration of the portfolio = (0.333333 x 7.5) +
(0.666667 × 5.4) = 6.099999 ≈ 6.1.
Fixed Income: calculate portfolio duration and convexity and explain the limitations of these
measures

79.
A. Incorrect because each denominator is raised to the power of the corresponding year.
PV ≠ PMT/ (1 +0y1y) + PMT/ (1+0y1y x 1y1y)2 + (PMT + FV)/(1+0y1y x 1y1y x 2y1y)3
PV ≠ 1/(1+1%) + 1/((1+1%) (1 + 2% ))2 + (1+100)/((1+1%) (1+2%) (1 + 4% ) )3 = 0.9901+0.9422
+82.1215 = 84.0538, rounded to 84.05.
B. Incorrect because the forward rates are used directly as spot rates. Hence,
PV ≠ PMT / (1 + Z1)1 + PMT / (1 + Z2)2 + ... + (PMT + FV) / (1 + ZN)N
PV ≠ 1/(1+1%)1 +1 / (1 +2%)2 + (1 + 100)/(1+4%)3 = 0.9901 +0.9612 +89.7886 = 91.7399,
rounded to
91.74.
C. Correct because the geometric average of the forward rates gives us the spot rates (ie.
(0y1y x 1y1y) = (1 + Z2)2, (0y1y x 1y1y x 2y1y) = (1 + Z3)3)), hence the price of a bond using
forward rates can be calculated using: PV = PMT / (1 + Z1)1 + PMT / (1 + Z2)2+. + (PMT +
FV)/(1+ZN)N where 𝑍1 = spot rate, or the zero-coupon yield, or zero rate, for Period 1, 𝑍2 =
spot rate, or the zero-coupon yield, or zero rate, for Period 2, 𝑍𝑁 = spot rate, or the zero-
coupon yield, or zero rate, for Period N.
PV> = PMT / (1 +0y1y) + PMT / (1 + 0y1y x 1y1y) + (PMT + FV) / (1 +0y1y x 1y1y x 2y1y)
PV = 1 / (1 +1%) + 1/((1+1%) (1+2% )) + (1 + 100)/((1+1%) (1+2%) (1+4%) = 0.9901+0.9707
+94.2685 = 96.2293, rounded to 96.23.
Fixed Income: define par and forward rates, and calculate par rates, forward rates from spot
rates, spot rates from forward rates, and the price of a bond using forward rates

80.
A. Incorrect because changes in interest rates change the future value of reinvested coupon
payments. Therefore, the investor faces coupon reinvestment risk, too.
B. Incorrect because the investor will be selling the bond before maturity and faces the risk
that it will be sold at a higher or lower price (market price risk).

34
CFA Program Level I for February 2024

C. Correct because the investor faces coupon reinvestment risk for all coupons received
(first coupon plus any others until sale) and also faces market price risk as changes in the
interest rate will impact the sale price of the bond.
Coupon reinvestment risk matters more when the investor has a long-term horizon relative
to the time-to-maturity of the bond. For instance, a buy-and-hold investor only has coupon
reinvestment risk. Market price risk matters more when the investor has a short-term
horizon relative to the time-to-maturity. For example, an investor who sells the bond before
the first coupon is received has only market price risk.
Fixed Income: calculate and interpret the sources of return from investing in a fixed-rate
bond;

81.
A. Incorrect because the yield-to-maturity on a corporate bond consists of a government
benchmark yield and a spread, a change in the bond's yield-to-maturity can originate in
either component or a combination of the two. The key point is that for an option-free
fixed-rate bond, the same duration and convexity statistics that apply for a change in
benchmark yield also apply for a change in spread
B. Incorrect because the yield-to-maturity on a corporate bond consists of a government
benchmark yield and a spread a change in the bond's yield-to-maturity can originate in
either component or a combination of the two The key point is that for an option-free fixed-
rate bond, the same duration and convexity statistics that apply for a change in benchmark
yield also apply for a change in spread.
C. Correct because the key point is that for an option-free fixed-rate bond, the same
duration and convexity statistics that apply for a change in benchmark yield also apply for a
change in spread.
Fixed Income: describe macroeconomic, market, and issuer-specific factors that influence
the level and volatility of yield spreads

82.
A. Incorrect because the yield-to-maturity, 𝑟𝑦𝑡𝑚 is : 105 = 4/(1 + rytm)1 + 4/(1 + rytm)2 + 4/(1 +
rytm)3 + 104/(1 + rytm)4
Using a financial calculator with N = 4, PV=-105, FV = 100, PMT=4 and solving for I, 𝑟𝑦𝑡𝑚 =
2.6656% ≈ 2.7%. Although less than the yield to first call of 2.9%, the YTM is greater (better)
than the yield to second call of 2.6%, making the latter the yield to worst.
B. Incorrect because the yield-to-first-call, r, is: 105 = 4/(1+r)^1+ (4+103)/(1+r)^2
Using a financial calculator with N = 2, PV=-105, FV = 103, PMT 4 and solving for I, r₁ =
2.8706% ≈ 2.9%. This yield is greater (better) than both the yield to second call of 2.6%
(which is the lowest, or worst) and the YTM of 2.7%,

35
CFA Program Level I for February 2024

C. Correct because the lowest of the sequence of yields-to-call and the yield-to-maturity is
known as the yield-to- worst. The sequence of yields for the bond is as follows:
Yield-to-maturity, Tem is calculated by solving this equation: 105 = 4/(1
+rytm)1+4/(1+гyem)2+4/(1+ryem)3 + 104/(1 + rytm)4
Using a financial calculator with N = 4, PV=-105, FV = 100, PMT=4 and solving for I, 𝑟𝑦𝑡𝑚 =
2.6656% ≈ 2.7%.
Yield-to-first-call, r, is calculated by solving this equation: 105 = 4/(1+r1)1+ (4+103)/(1+r1)2
Using a financial calculator with N = 2, PV=-105, FV = 103, PMT=4 and solving for 1, r =
2.8706% ≈ 2.9%.
Yield-to-second-call, r, is calculated by solving this equation: 105 = 4/(1 + r2)1 +
4/(1+r2)2+(4+101)/(1+r2)3Using a financial calculator with N = 3, PV=-105, FV = 101, PMT=4
and solving for I, r2 = 2.5718% ≈ 2.6%.
Therefore the yield-to-worst is equal to the yield-to-second-call.
Fixed Income: compare, calculate, and interpret yield and yield spread measures for fixed-
rate bonds

83.
A. Incorrect because the Macaulay and modified duration statistics for a fixed-rate bond
depend primarily on the coupon rate, yield-to-maturity, and time-to-maturity. A higher
coupon rate or a higher yield-to-maturity reduces the duration measures A longer time-to-
maturity usually leads to a higher duration. It always does so for a bond priced at a premium
or at par value. Bond 1 has a lower coupon than Bond 3, a lower yield-to-maturity, and a
longer maturity. The Macaulay duration of Bond 1 is therefore greater than that of Bond 3.
B. Incorrect because the Macaulay and modified duration statistics for a fixed-rate bond
depend primarily on the coupon rate, yield-to-maturity, and time-to-maturity. A higher
coupon rate or a higher yield-to-maturity reduces the duration measures. A longer time-to-
maturity usually leads to a higher duration. It always does so for a bond priced at a premium
or at par value. Bond 2 has a lower coupon than Bond 3, the same yield-to-maturity, and a
longer maturity The Macaulay duration of Bond 2 is therefore greater than that of Bond 3.
C. Correct because the Macaulay and modified duration statistics for a fixed-rate bond
depend primarily on the coupon rate, yield-to-maturity, and time-to-maturity. A higher
coupon rate or a higher yield-to-maturity reduces the duration measures. A longer time-to-
maturity usually leads to a higher duration. It always does so for a bond priced at a premium
or at par value." In this case, Bond 3 has a higher coupon, the same or higher yield-to-
maturity, and the shortest time to maturity. It therefore has the lowest Macaulay duration.
Fixed Income: explain how a bond's maturity, coupon, and yield level affect its interest rate
risk

36
CFA Program Level I for February 2024

84.
A. Incorrect because it multiplies the modified duration with the clean price instead of the
full price.
4.8250 x 114.75 = 553.6688 ≈ 553.67.
B. Correct because the money duration equals the product of modified duration and full
price
Full price = Clean price + Accrued interest = 114.75 + 1.625 = 116.375;
Money duration = Modified duration x Full Price = 116.375 x 4.8250 = 561.5094 ≈ 561.51.
Modified duration is a measure of the percentage price change of a bond given a change in
its yield-to-maturity. A related statistic is money duration. The money duration of a bond is
a measure of the price change in units of the currency in which the bond is denominated.
The money duration can be stated per 100 of par value or in terms of the actual position
size of the bond in the portfolio. In the United States, money duration is commonly called
'dollar duration 'Money duration (MoneyDur) is calculated as the annual modified duration
times the full price (𝑃𝑉 𝐹𝑢𝑙𝑙 ) of the bond, including accrued interest.
C. Incorrect because it multiplies the full price with the Macaulay duration instead of the
modified duration.
Full price = Clean price + Accrued interest = 114.75 + 1.625 = 116.375,
Macaulay duration x Full price = 4.9469 x 116.375 = 575.6955 ≈ 575.70.
Fixed Income: define, calculate, and interpret modified duration, money duration, and the
price value of a basis point (PVBP)

85.
A. Incorrect because although effective duration is the most appropriate interest rate risk
measure for bonds with embedded options, it also is useful with traditional bonds to
supplement the information provided by the Macaulay and modified yield durations.
B. Incorrect because a practical consideration in using effective duration is in setting the
change in the benchmark yield curve. With approximate modified duration, accuracy is
improved by choosing a smaller yield-to-maturity change. But the pricing models for more-
complex securities, such as callable and mortgage-backed bonds, include assumptions about
the behavior of the corporate issuers, businesses, or homeowners. Rates typically need to
change by a minimum amount to affect the decision to call a bond or refinance a mortgage
loan because issuing new debt involves transaction costs. Therefore, estimates of interest
rate risk using effective duration are not necessarily improved by choosing a smaller change
in benchmark rates.

37
CFA Program Level I for February 2024

C. Correct because the modified duration and effective duration on an option-free bond are
identical only in the rare circumstance of an absolutely flat yield curve.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

86.
A . Incorrect because it weights the bonds by par value.
DP= [(100,000 ÷ 300,000) x 5] + [(200,000 ÷ 300,000) × 4]
= (0.333 × 5) + (0.667 × 4)
= 1.665 + 2.668
= 4.333 = 4.33
B. Correct because the portfolio's duration is the weighted average (by market value) of the
duration of the bonds in the portfolio.
Duration of portfolio = [(120,000 ÷ 300,000) x 5] + [(180,000 ÷ 300,000) × 4]
= (0.4 x 5)+(0.6 × 4)
= 2.00 +2.40
= 4.40
C. Incorrect because it weights the bonds by their duration.
DP= [(5÷9) x 5] + [(4÷9) x 4)]
= 2.777 +1.777
= 4.5544.55
Fixed Income: calculate portfolio duration and convexity and explain the limitations of these
measures

87.
A. Incorrect because as per the justification for the correct answer, the price of the bond is
closest to $97,277. This incorrect answer is arrived at by ignoring the coupon payments for
year 1 & 2:
Price of bond ≠ 104,000/(1+5% )3 = 89,839.11025 ≈ 89,839.
B. Correct because the price of the bond is the present value of the promised cash flows and
is calculated as follows:
Price of bond = 4,000/ (1 +5%)1 + 4,000 / (1+5% )² + 104,000 / (1+5%)3 = 3,809.5238 +
3,628.1179 + 89,839.1102 = 97,276.7520 ≈ 97,277. Calculator inputs: FV = 100,000, I =
10.05, N = 3, PMT = 4,000, PV = 97,276.75 ≈ 97.277.
C. Incorrect because as per the justification for the correct answer, the price of the bond is
closest to $97,277. This incorrect answer is arrived at by switching the coupon rate and the

38
CFA Program Level I for February 2024

market discount rate.

Price of bond ≠ 5,000/(1+4%)1 +5,000/(1+4% )² + 105,000/(1+4%)3 = 4,807.6923 +
4,622.7811 + 93,344.6177 = 102,775.0910 ≈ 102,775. Calculator inputs: FV = 100,000, I=
0.04, N=3, PMT = 5,000, PV = 102,775.09 ≈ 102,775.
Fixed Income: calculate a bond's price given a yield-to-maturity on or between coupon
dates

88.
A. Incorrect because in a recourse loan, the lender has a claim against the borrower for the
shortfall between the amount of the outstanding mortgage balance and the proceeds
received from the sale of the property. In a non- recourse loan, the lender does not have
such a claim and thus can look only to the property to recover the outstanding mortgage
balance.
B. Incorrect because a mortgage may entitle the borrower to prepay all or part of the
outstanding mortgage principal prior to the scheduled due date when the principal must be
repaid. This contractual provision is referred to as a prepayment option or an early
repayment option. From the lender's or investor's viewpoint, the effect of a prepayment
option is that the amount and timing of the cash flows from a mortgage cannot be known
with certainty. The prepayment option benefits the borrower rather than the lender.
C. Correct because the purpose of the prepayment penalty is to compensate the lender for
the difference between the contract rate and the prevailing mortgage rate if the borrower
prepays when interest rates decline.
Fixed Income: describe fundamental features of residential mortgage loans that are
securitized

89.
A. Incorrect because recognizing these different payment priorities, and thus the potential
for higher (or lower) loss severity in the event of default, the rating agencies have adopted a
notching process whereby their credit ratings on issues can be moved up or down from the
issuer rating, which is usually the rating applied to its senior unsecured debt. Issue ratings
are thus notched up or down from the issuer rating, and not from more junior ratings such
as junior subordinated ratings.
B. Correct because the rating agencies have adopted a notching process whereby their
credit ratings on issues can be moved up or down from the issuer rating, which is usually the
rating applied to its senior unsecured debt As a general rule, the higher the senior
unsecured rating, the smaller the notching adjustment.
C. Incorrect because recognizing these different payment priorities, and thus the potential
for higher (or lower) loss severity in the event of default, the rating agencies have adopted a

39
CFA Program Level I for February 2024

notching process whereby their credit ratings on issues can be moved up or down from the
issuer rating and also cross-default provisions, whereby events of default (such as non-
payment of interest) on one bond trigger default on all outstanding debt, imply the same
default probability for all issues, specific issues may be assigned different credit ratings-
higher or lower-due to a rating adjustment methodology known as notching. It is the higher
loss severity, and not higher probability of default, that is driving the notching process.
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

90.
A. Incorrect because bond yields-to-maturity are annualized and compounded. Yield
measures in the money market are annualized but not compounded.
B. Incorrect because money market instruments having different times-to-maturity have
different periodicities for the annual rate.
C. Correct because the rate of return on a money market instrument is stated on a simple
interest basis.
Fixed Income: calculate and interpret yield measures for money market instruments

91.
A. Incorrect because, since the reinvestment rate is less than the horizon yield, the yield-to-
maturity is greater than the horizon yield of 4.2%
B. Incorrect because, since the reinvestment rate is less than the horizon yield, the yield-to-
maturity is greater than the horizon yield of 4.2%
C. Correct because the realized horizon yield matches the original yield-to-maturity if (1)
coupon payments are reinvested at the same interest rate as the original yield-to-maturity,
and (2) the bond is sold at a price on the constant-yield price trajectory, which implies that
the investor does not have any capital gains or losses when the bond is sold. Since the
reinvestment rate is less than the horizon yield and the bond is held to maturity, the yield to
maturity is greater than the horizon yield.
Fixed Income: calculate and interpret the sources of return from investing in a fixed-rate
bond;

40
CFA Program Level I for February 2024

92.
A. Correct because the value of a bond is calculated as:
PV= [PMT = (1+r)¹] + [PMT +(1+r)²] +...+ [(PMT + FV) + (1+r)N)
where:
PV= present value, or the price of the bond
PMT coupon payment per period
FV = future value paid at maturity, or the par value of the bond
r = market discount rate, or required rate of return per period
N= number of evenly spaced periods to maturity
Using calculator inputs, N = (3 x 2)=6, PMT = (5% ÷ 2) 100 = $2.5, FV = $100, PV = $108,
Solve for I, is equal to 1.114% semi-annually, or 2.228% on an annual basis. If the yield to
maturity decreases by 100 bps, the price of the bond after one year is computed as: N = 4,
PMT = $2.5, FV = $100, 1= [(2.228% -1% ) ÷ 2] = 0.614%, Solve PV, is equal to $107.43.
Therefore, the change in value of the bond = $108.00 - $107.43 = $0.57
B. Incorrect because fails to annualize the interest rate before computing the change in
value
Using calculator inputs, the yield of the bond: N=6, PMT = $2.5, FV = $100, Solve I is equal to
1.114%.
If the yield declines by 100 bps, the price of the bond after one year is computed as: N = 4,
PMT = $2.5, FV = 100, I = (1.114% -1% ) = 0.114%, Solve for PV = $109.52.
Therefore, the change in value = $108-109.52-$1.52, or a change in value of $1.52
C. Incorrect because incorrectly uses the same time to maturity when calculating the new
value rather than adjusting the term for the passage of one year in value
Using calculator inputs, the yield of the bond: N = 6, PMT = $2.5, FV = 100, I = (2.228% -
1%)/2=0.614%, Solve for PV is equal to $111.08.
Therefore, the change in value = $108-111.08 = - $3.08, or a change in value of $3.08.
Fixed Income: calculate a bond's price given a yield-to-maturity on or between coupon
dates

93.
A. Correct because the yield spread of a specific bond over the standard swap rate in that
currency of the same tenor is known as the I-spread or interpolated spread to the swap
curve.
B. Incorrect because another approach is to calculate a constant yield spread over a
government (or interest rate swap) spot curve instead. This spread is known as the zero
volatility spread (Z-spread) of a bond over the benchmark rate. Sometimes, the Z-spread is
called the static spread because it is constant (and has zero volatility).

41
CFA Program Level I for February 2024

C. Incorrect because the Z-spread is also used to calculate the option-adjusted spread (OAS)
on a callable bond. The OAS, like the option-adjusted yield, is based on an option- pricing
model and an assumption about future interest rate volatility.
Fixed Income: compare, calculate, and interpret yield and yield spread measures for fixed-
rate bonds

94.
A. Correct because there are two offsetting types of interest rate risk that affect the bond
investor coupon reinvestment risk and market price risk. The future value of reinvested
coupon payments (and in a portfolio, the principal on bonds that mature before the horizon
date) increases when interest rates go up and decreases when rates go down. The sale price
on a bond that matures after the horizon date (and thus needs to be sold) decreases when
interest rates go up and increases when rates go down.
B. Incorrect because the future value of reinvested coupon payments (and in a portfolio, the
principal on boods that mature before the horizon date) increases when interest rates go
up. The sale price on a bond that matures after the horizon date (and thus needs to be sold)
decreases when interest rates go up.
C. Incorrect because the future value of reinvested coupon payments (and in a portfolio, the
principal on bonds that mature before the horizon date) increases when interest rates go
up. The sale price on a band that matures after the horizon date (and thus needs to be sold)
decreases when interest rates go pp.
Fixed Income: describe the relationships among a band's holding period return, its
Macaulay duration, and the investment horizon

95.
A. Correct because this is a secured debt and therefore has higher priority than any
unsecured debt. In the event of default, unsecured debtholders' claims rank below (ie., get
paid after) those of secured creditors under what's known as the priority of claims. First lien
debt or loan refers to a pledge of certain assets that could include buildings but might also
include property and equipment, licenses, patents, brands, and so on. There can also be
second lien, or even third lien, secured debt, which, as the name implies, has a secured
interest in the pledged assets but ranks below first lien debt in both collateral protection
and priority of payment.
B. Incorrect because within unsecured debt, there can also be finer gradations and seniority
rankings. The highest- ranked unsecured debt is senior unsecured debt. It is the most
common type of all corporate bonds outstanding. Other, lower-ranked debt includes
subordinated debt and junior subordinated debt. Among the various creditor classes, these

42
CFA Program Level I for February 2024

obligations have among the lowest priority of claims and frequently have little or no
recovery in the event of default.
C. Incorrect because in the event of default, unsecured debtholders' claims rank below (i.e.,
get paid after) those of secured creditors under what's known as the priority of claims.
Within unsecured debt, there can also be finer gradations and seniority rankings. The
highest-ranked unsecured debt is senior unsecured debt.
Fixed Income: describe the seniority rankings of debt, secured versus unsecured debt and
the priority of claims in bankruptcy, and their impact on credit ratings

96.
A. Incorrect because the yield spread of a specific bond over the standard swap rate in that
currency of the same tenor is known as the I- spread.
B. Correct because the yield spread in basis points over an actual or interpolated
government bond is known as the G-spread. The spread over a government bond is the
return for bearing greater credit, liquidity, and other risks relative to the sovereign bond.
C. Incorrect because the yield spread over a specific benchmark is referred to as the
benchmark spread. A constant yield spread over a government (or interest rate swap) spot
curve is known as the zero-volatility spread (Z- spread) of a bond over the benchmark rate.
Fixed Income: compare, calculate, and interpret yield and yield spread measures for fixed-
rate bonds

97.
A. Incorrect because this relates to credit tranching, not time tranching. In credit tranching,
there is more than one bond class or tranche, and the share classes differ as to how they
will share losses resulting from defaults of the borrowers whose loans are in the collateral.
B. Correct because the creation of bond classes that possess different expected maturities is
referred to as time tranching.
C. Incorrect because tranching does not change underlying collateral, rather it only changes
how losses or prepayments will be shared. In such a structure, there is more than one bond
class or tranche, and the share classes differ as to how they will share losses resulting from
defaults of the borrowers whose loans are in the collateral.
Fixed Income: define prepayment risk and describe time tranching structures in
securitizations and their purpose

43
CFA Program Level I for February 2024

98.
A. Incorrect because a specified yield spread is added to, or subtracted from, the reference
rate which results in the coupon. For example, the floater might reset its interest rate
quarterly at three-month Libor plus 0.50%. This is not the quoted margin, it is the reference
rate plus the quoted margin.
B. Correct because this specified yield spread over the reference rate is called the quoted
margin on the FRN. The role of the quoted margin is to compensate the investor for the
difference in the credit risk of the issuer and that implied by the reference rate.
C. Incorrect because the required margin is the yield spread over, or under, the reference
rate such that the FRN is priced at par value on a rate reset date. Changes in the required
margin usually come from changes in the issuer's credit risk. The required margin is not
specified but changes based on market forces.
Fixed Income: calculate and interpret yield spread measures for floating-rate instruments

99.
A. Incorrect because the candidate calculates the Macaulay duration incorrectly: MacDur ≠
7.4/(1+9%) = 6.8. Because the duration gap is equal to the bond's Macaulay duration minus
the investment horizon the investment horizon is incorrectly stated as 6.8 years.
B. Incorrect because the candidate confuses the Macaulay duration with the modified
duration, thus incorrectly determining the investment horizon as 7.4 years.
C. Correct because we use the fact that ModDur = MacDur /(1+r) to calculate the Macaulay
duration of the bond: MacDur = 7.4 × (1+9%) = 8.07. Because the duration gap is equal to
the bond's Macaulay duration minus the investment horizon the investment horizon is
closest to 8.1 years.
Fixed Income: describe the relationships among a bond's holding period return, its
Macaulay duration, and the investment horizon;

100.
A. Incorrect because if interest rates are low compared with the coupon rate, the value of
the put option is low and the impact of a change in the benchmark yield on the [putable]
bond's price is very similar to the impact on the price of a non-putable bond, e.g., not
limited. Furthermore, a rational investor would not exercise the put option when the
market interest rate is lower than the coupon rate of the bond.
B. Correct because when interest rates are low, the effective duration of the callable bond is
lower than that of the otherwise comparable non-callable bond because the callable bond
price does not increase as much when benchmark yields fall. The presence of the call option

44
CFA Program Level I for February 2024

limits price appreciation especially when interest rates are falling and the bond is more
likely to be called.
C. Incorrect because the presence of an embedded option reduces the sensitivity of the
bond price to changes in the benchmark yield curve, assuming no change in credit risk. An
option-free bond serves as the base case, whereas with a call, price appreciation is limited
when market rates go below the coupon rate [and with a put, price depreciation is limited
when market rates go above the coupon rate].
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

101.
A. Incorrect because when the benchmark yield is high and the value of the embedded call
option is low, the callable and the non-callable bonds experience very similar effects from
interest rate changes. They both have positive convexity But as the benchmark yield is
reduced the curves diverge At some point, the callable bond moves into the range of
negative convexity, which indicates that the embedded call option has more value to the
issuer and is more likely to be exercised
B. Incorrect because when the benchmark yield is high and the value of the embedded call
option is low, the callable and the non-callable bonds experience very similar effects from
interest rate changes. They both have positive convexity. But as the benchmark yield is
reduced, the curves diverge At some point, the callable bond moves into the range of
negative convexity, which indicates that the embedded call option has more value to the
issuer and is more likely to be exercised.
C. Correct because when the benchmark yield is high and the value of the embedded call
option is low, the callable and the non-callable bonds experience very similar effects from
interest rate changes. They both have positive convexity But as the benchmark yield is
reduced, the curves diverge. At some point, the callable bond moves into the range of
negative convexity, which indicates that the embedded call option has more value to the
issuer and is more likely to be exercised.
Fixed Income: explain why effective duration and effective convexity are the most
appropriate measures of interest rate risk for bonds with embedded options

102.
A. Incorrect because capital gains and losses are measured from the carrying value of the
bond and not from the purchase price or par value.
B. Correct because capital gains arise if a bond is sold at a price above its constant-yield
price trajectory and capital losses occur if a bond is sold at a price below its constant-yield
price trajectory. Also, capital gains and losses are measured from the carrying value of the

45
CFA Program Level I for February 2024

bond and not from the purchase price. The carrying value includes the amortization of the
discount or premium if the bond is purchased at a price below or above par value. The
carrying value is any point on the constant-yield price trajectory.
C. Incorrect because capital gains and losses are measured from the carrying value of the
bond and not from the purchase price.
Fixed Income: calculate and interpret the sources of return from investing in a fixed-rate
bond

103.
A. Incorrect because the sale and purchase price are accidentally swapped in the formula:
102.06 = (95.27 +24.28)/(1+r)^7 => r = 0.022853 ≈ 2.29%.
Calculator solution: N = 7; PV = -102.06; FV = 95.27+ 24.28; CPT I/Y = 2.29%
B. Incorrect because holding period and tenor of bond are accidentally swapped in the
formula:
95.27 (102.06+24 28)/(1+r)^10=> r = 0.028628 ≈ 2.86%.
Calculator solution: N = 10, PV= -95 27, FV = 102.06 + 24.28; CPT I/Y= 2.86%.
C. Correct because a horizon yield is the internal rate of return between the total return
(the sum of reinvested coupon payments and the sale price or redemption amount) and the
purchase price of the bond. The horizon yield on a bond investment is the annualized
holding-period rate of return.
95.27 = (102.06+24.28)/ (1+r)^7 => r = 0.041147 ≈ 4.11%.
Calculator solution: N = 7; PV= -95.27; FV = 102.06 + 24.28; CPT I/Y = 4.11%.
Fixed Income: calculate and interpret the sources of return from investing in a fixed-rate
bond;

104.
A. Incorrect because candidates confuse the redemption value with the present value and
thereby add the interest earned to the redemption value as part of the calculation.
DR ≠ (365/160) x (140,500/(5,000,000 + 140,500)) = 0.0624 ≈ 6.2%.
B. Correct because the discount rate, DR = (Year/Days) x ((FV - PV)/FV), where Year =
number of days in the year, Days = number of days between settlement and maturity, FV =
future value paid at maturity/face value of the money market instrument, PV = present
value/price of the money market instrument, and FV - PV, is the interest earned.
DR = (365/160) x (140,500/5,000,000) = 0.0641 ≈ 6.4%.

46
CFA Program Level I for February 2024

C. Incorrect because this is the add-on rate. AOR = Year/Days x ((FV-PV)/PV)

AOR = (365/160) x (140,500/(5,000,000-140,500)) = 0.0660 ≈ 6.6%.
Fixed Income: calculate and interpret yield measures for money market instruments

105.
A. Incorrect because the two bonds are assumed to have the same price, yield-to-maturity,
and modified duration. The benefit of greater convexity occurs when their yields-to-
maturity change. For the same decrease in yield-to-maturity, the more convex bond
appreciates more in price. And for the same increase in yield-to-maturity, the more convex
bond depreciates less in price. The conclusion is that the more convex bond outperforms
the less convex bond in both bull (rising price) and bear (falling price) markets. The more
convex bond always outperforms the less convex bond
B. Incorrect because the two bonds are assumed to have the same price, yield-to-maturity,
and modified duration. The benefit of greater convexity occurs when their yields-to-
maturity change. For the same decrease in yield-to-maturity, the more convex bond
appreciates more in price. And for the same increase in yield-to-maturity, the more convex
bond depreciates less in price. The conclusion is that the more convex bond outperforms
the less convex outperforms bond in both bull (rising price) and bear (falling price) markets.
The more convex bond always the less convex bond.
C. Correct because the two bonds are assumed to have the same price, yield-to-maturity,
and modified duration. The benefit of greater convexity occurs when their yields-to-
maturity change. And for the same increase in yield-to-maturity, the more convex bond
depreciates less in price [than the less convex bond].
Fixed Income: calculate and interpret convexity and describe the convexity adjustment

106.
A. Incorrect because both the coupon payment and discount rate used are annual:
PV=

12 12 12
+ +
(1 + 0.04)1 (1 + 0.04)2 (1 + 0.04)3
=122.2007~122.20

47
CFA Program Level I for February 2024

B. Correct because PV=

6 6 6 6 6 6
1
+ 2
+ 3
+ 4
+ 5
+
(1 + 0.02) (1 + 0.02) (1 + 0.02) (1 + 0.02) (1 + 0.02) (1 + 0.02)6
=122.4057~122.41
C. Incorrect because the the coupon payment and discount rate are annual, similar to the
other distractor. The difference between this and other distractor is that payment is made
at the beginning of the period, not at the end. = 122.53
Fixed-Income Bond Valuation: Prices and Yields: calculate a bond's price given a yield-to-
maturity on or between coupon dates

48