CFA Exam Question of the Day

Level I | Level II | Level III

2024-06-12

Question:
The required rate of return on a bond with a 5 year maturity:

Select an Answer:
would be higher than that on an otherwise identical bond with a 10-year maturity.
would be the same as that on an otherwise identical bond with a 10-year maturity.
would be lower than that on an otherwise identical bond with a 10-year maturity.
would be lower than that on a bond with lower risk.
Rationale:
The yield curve typically slopes upward because investors expect future short-term rates to be above current short-term rates. Remember, Yield-to-Maturity is on the Y-axis and Years to Maturity is on the X-axis. This upward slope means that the rate of return will generally be higher on bonds with longer maturities, other things being equal. To put this into perspective, an investor with funds committed for 5 years is not assuming as much risk (potential loss of market interest rate return) as an investor with funds committed for ten years.

2024-06-11

Question:
The borrowing rate for a repurchase agreement, which is usually less than the cost of borrowing from a bank, is known as the ________.

Select an Answer:
discount rate
pro rata rate
cap rate
repo rate
Rationale:
A repurchase agreement is the sale of a security with a commitment by the seller to buy the same security at a specified price and date. The borrowing rate on the repurchase agreement is known as the repo rate.

The pro rata rate does not exist as a term. The discount rate is used to calculate the present value of cash flows. The cap rate is the maximum coupon rate that will be paid at the reset date on a floating rate security.

2024-06-10

Question:
Which of the following statements is/are true when all other factors are held constant?

I. The longer a bond's maturity, the more sensitive the bond will be to changes in interest rates.

II. The shorter a bond's maturity, the more sensitive the bond will be to changes in interest rates.

III. Bonds with high coupon rates are more sensitive to changes in interest rates.

IV. Bonds with lower coupon rates are more sensitive to changes in interest rates.

Select an Answer:
I and IV
I only
III only
I and III only
II and III only
Rationale:
Longer maturity bonds will exhibit greater sensitivity to changes in the level of interest rates when compared to shorter maturity bonds. Additionally, lower coupon bonds will have greater sensitivity than high coupon bonds. Zero-coupon bonds therefore, will be very sensitive to changes in rates.

2024-06-09

Question:
The interest rate that an issuer agrees to pay the bondholder each year is referred to as the ________.

Select an Answer:
effective rate
principal yield
quoted margin
coupon rate
capitalization rate
Rationale:
The coupon rate, otherwise known as nominal rate, is the interest rate that the issuer promises to pay the bondholder annually. The coupon is determined by multiplying the coupon rate by the par value of the bond (Coupon = Coupon rate × Par value).

2024-06-08

Question:
For small changes in yields, prices of option-free bonds vary:

Select an Answer:
logarithmically with modified duration.
exponentially with modified duration.
proportionally with modified duration.
linearly with modified duration.
Rationale:
The relationship between price and modified duration is given by %P = (-D) × (*i), where %P is the percent change in the price of the bond, D is the modified duration of the bond, and *i is the yield change in basis points divided by 100. It has been shown that price movements of option-free bonds will vary proportionally with modified duration for small changes in yields.

Specifically, an estimate of the percentage change in bond price equals the change in yield times modified duration.

Note: Modified duration is always a negative value for a noncallable bond because of the inverse relationship between yield changes and bond price changes.