Level 1 CFA® Exam Fixed Income Relations
soleadea
1 year 2 weeks 5 days
This blog post was created as a part of the CFA exam review series to help you in your level 1 exam revision, whether done regularly or shortly before your CFA exam.
In this post, we cover the most important relations between variables from the Fixed Income level 1 CFA exam topic.
Inverse Relationship between Interest Rate and Bond Price
Let’s begin with some basics, namely the relationship between the market discount rate and the bond price.
Generally, there is an inverse relationship between interest rates and the price of a bond.
If:
interest rates go up the price of a bond goes down,
interest rates go down the price of the bond goes up.
If:
the required yield changes only a bit (it either increases or decreases a bit) the absolute value of the percentage change in the bond price will be approximately the same for both increase and decrease of the market discount rate
the required yield changes a lot the absolute value of the percentage change in the bond price will be lower if the market discount rate increases than if the discount rate decreases
Coupon Rate vs YTM
coupon rate > YTM the bond sells at a premium (the bond price is higher than the par value)
coupon rate = YTM the bond sells at par (the bond price is equal to the par value)
coupon rate the bond sells at a discount (the bond price is lower than the par value)
coupons’ reinvestment rate investment's realized rate of return
coupons’ reinvestment rate > YTM investment's realized rate of return > YTM
Callable Bond vs Putable Bond
value of the callable bond = value of the bond without an embedded option - value of the call option
value of the putable bond = value of the bond without an embedded option + value of the put option
volatility of the market discount rate increases call option value increases callable bond value decreases
volatility of the market discount rate increases put option value increases putable bond value increases
Spot Curve vs Forward Curve
spot curve is upward sloping forward curve is above the spot curve
spot curve is downward sloping forward curve is under the spot curve
Reinvestment Risk vs Market Price Risk
the lower the coupon rate the lower the reinvestment risk
the lower the coupon rate the higher the market price risk
Bond's Price Change (Duration Only)
the greater the modified duration the greater the percentage bond price change
the lower the modified duration the lower the percentage bond price change
the greater the yield change (yield volatility) the greater the percentage bond price change
the lower the yield change (yield volatility) the lower the percentage bond price change
LAST UPDATE: 2 Nov 2023