Fixed Income for CFA Level 1: Your Path to Bond Mastery

Hello, future finance wizards! In this article, we’ll explore the Fixed Income topic of the CFA Level 1 exam, guiding you through each reading to help you bond with bonds (pun intended!). So, let’s dive into the world of fixed income and uncover the secrets of these crucial financial instruments!

1. Fixed-Income Instrument Features

Venture into the realm of fixed-income investments and discover the building blocks of bonds, including their features, how they’re structured, and what makes them tick. You’ll get to grips with the foundational elements like maturity dates, coupon rates, and how they’re used in the real world of finance.

  • Basic Features of Fixed Income Securities: Grasp the fundamentals of bonds including key elements, different types of issuers, maturity dates, par value, coupon rates, currency denominations, and yield measures.
  • Contents of a Bond Indenture: Dive into the nitty-gritty of bond indentures, from trust deeds and repayment sources to the intricacies of asset-backed securities and the safeguards of credit enhancements and covenants.

2. Fixed Income Cash Flows and Types

Embark on an intriguing exploration of fixed income securities, a critical player in the investment arena. This journey takes you through the diverse range of coupon structures, the legal, regulatory, and tax considerations, and finally, the adventurous terrain of contingency provisions.

  • Coupon Structures: Understand the extensive variety of coupon structures in the bond market, from bullet coupons to inverse floaters and index-linked bonds.
  • Contingency Provisions: Venture into the world of bond indentures and contingency provisions, exploring issuer-exercisable options, bondholder-exercisable options, and alternatives to convertible bonds.
  • Legal, Regulatory, and Tax Considerations: Familiarize yourself with global regulatory requirements of bonds, including domestic, foreign, Eurobonds, Global bonds, and how interest income and capital gains are taxed.

3. Fixed-Income Issuance and Trading

Unearth the secrets of fixed-income markets, dissecting everything from bond issuance to trading and funding. This includes a thorough survey of global fixed income markets, an exploration of primary and secondary bond markets, a look into government and related sectors’ bonds, corporate debt, structured financial instruments, and short-term funding for banks.

  • Fixed-Income Segments, Issuers, and Investors: Learn to identify bonds based on issuer, taxable status, credit quality, currency of issuance, original maturity, coupon structure, and indexing, while understanding the nuances of emerging and developed markets.
  • Types of Fixed Income Indexes: Set off on a journey to explore the wide universe of fixed income indexes! Discover the breadth of fixed-income securities and their varied dimensions, from issuer type to coupon structures.
  • Primary and Secondary Bond Markets: Grasp how bonds are issued, traded, and priced in both primary and secondary markets, covering public offerings to private placements.

4. Fixed-Income Markets for Corporate Issuers

Unpack the essentials of fixed-income markets for corporate issuers, where you’ll navigate through the strategies behind short-term funding, the mechanics of repurchase agreements, and the pivotal role of long-term corporate debt. This lesson offers a comprehensive understanding of how corporations engage with the fixed-income market to optimize their financial strategies and structure.

  • Short-Term Funding Alternatives: Decode the complicated jargon of retail deposits, certificates of deposit, reserve funds, and interbank funds.
  • Repurchase Agreements: Jump into the fast-paced world of repurchase agreements (repos), a cornerstone of short-term financing where securities are sold with a promise to buy back later.
  • Long-Term Corporate Debt: Navigate the maze of corporate debt, mastering bilateral and syndicated loans, US and Euro commercial paper, and complex structures of corporate bonds.

5. Fixed-Income Markets for Government Issuers

Embark on an exploration of the fixed-income markets tailored for government issuers, shedding light on the spectrum from sovereign to quasi-government bonds, and diving into the process of sovereign debt issuance and trading. This journey equips you with the knowledge to navigate the complexities of government borrowing and the flow of these securities in the global marketplace.

6. Fixed-Income Bond Valuation: Prices and Yields

Step into the realm of fixed-income valuation, where you’ll understand bond pricing, yield measures, interest rates, and yield spreads. This path will help you calculate bond prices and differentiate between full and flat prices.

  • Bond Prices and Time Value of Money: Learn the art of calculating yield-to-maturity (YTM) using a bond’s market price and understand the assumptions that underpin this calculation.
  • Bond Prices: Quotes and Calculations: Distinguish between the full and flat prices of a bond, calculate these prices and accrued interest, and learn to estimate a bond’s price and market discount rate using matrix pricing.

7. Yield and Yield Spread Measures

Dive into the nuances of yield and spread measures for fixed-rate bonds to grasp how investors compare and assess bond investment opportunities. You’ll untangle the complex interplay of yield-to-maturity, effective yield, and the specific yield measures applicable to callable bonds, floating-rate notes, and money market instruments.

  • Bond Yield Measures: Understand how to compare different bond investment opportunities based on yield-to-maturity and effective yield, and delve into the yield measures for callable bonds, floating rate notes, and money market instruments.
  • Yield Spreads: Decode the components of a bond’s yield-to-maturity, discern the differences between macro and microeconomic influences on yield spreads, and engage in G-spread and I-spread calculations.

8. The Term Structure of Interest Rates: Spot, Par, and Forward Curves

In this lesson, you’ll turn into a yield curve conqueror, cracking open the mysteries of the term structure of interest rates. You’ll navigate the terrains of coupon bonds yield curves, spot rate yield curves, and par bond yield curves. Not to mention, you’ll also learn to calculate forward rates and price bonds, all with a sprinkle of fixed income magic.

► Embark on your yield curve conquest here.

9. Understanding Fixed-Income Risk and Return

Delve into the dynamic world of fixed-income risk and return, exploring the various factors that influence these investments and the tools used to assess and manage the associated risks. Grasp key concepts from sources of return to empirical duration, and learn how to navigate the complexities of fixed-income investments effectively.

  • Sources of Return: Unpack the components of return in fixed-rate bonds, including coupon and principal payments, reinvestment returns, and potential gains or losses from bond sales.
  • Macaulay Duration: Discover how to calculate the Macaulay duration and understand the duration gap’s significance in investment returns.
  • Modified Duration and Money Duration: Learn about modified and money duration and the Price Value of a Basis Point (PVBP), critical elements in predicting bond price changes.
  • Approximate Modified Duration and Convexity Adjustment: Learn how these calculations help estimate changes in bond price due to shifts in yield-to-maturity.
  • Effective Duration and Key Rate Duration: Understand the nuances of effective and key rate duration, integral measures for bonds with embedded options and under varying yield curve scenarios.
  • Duration of a Bond Portfolio: Explore how to calculate the duration of a bond portfolio using the Aggregated Cash Flows Approach and the Weighted Average Method.
  • Factors that Influence Interest Rate Risks: Understand how time to maturity, coupon rate, and yield-to-maturity contribute to a bond’s interest rate risk.
  • Empirical Duration: Differentiate between empirical and analytical duration, focusing on their role in measuring the sensitivity of a bond’s price to interest rate changes.

10. Credit Risk

Embark on an engaging exploration of credit analysis, as we delve into the crucial elements of credit risk assessment and the factors that influence creditworthiness. From the basics of credit risks to the intricacies of sovereign and non-sovereign credit analysis, you’ll gain a comprehensive understanding of how to evaluate credit and navigate the world of corporate debt.

  • Sources of Credit Risk: Learn the core aspects of credit risk, including default risk and loss severity, and how they interact with factors such as yield spreads and credit migration risk.
  • Credit Ratings and Ratings Agencies: Understand the intricate relationship between a company’s capital structure and credit risk, highlighting the difference between secured and unsecured debt.
  • Credit Yields and Spreads: Uncover the factors that influence credit yields and spreads and learn how to calculate bond price changes based on spread changes.

11. Credit Analysis

Master the art of credit analysis, diving into the core of evaluating corporate and sovereign creditworthiness. This lesson takes you through the nuances of credit risks, the significance of capital structure, the intricacies of credit ratings, and the analytical depth required for corporate credit assessment.

12. Fixed-Income Securitization

Ever wondered how asset-backed securities (ABS) are structured and protected in case of a bankruptcy? Well, wonder no more! This lesson takes you on a journey through the landscape of ABS and then zips you over to the realm of covered bonds. We’ll compare and contrast the two, and even dip our toes into the nitty-gritty of different types of covered bonds.

► Embark on this fantastic financial journey here.

13. Asset-Backed Security (ABS) Instrument and Market Features

Unpack the captivating world of asset-backed securities in this topic. From the basic principles of securitisation to the intricate details of collateralised debt obligations, this journey will provide an in-depth understanding of various forms of asset-backed securities and their respective risks and rewards.

  • Covered Bonds: Discover the ins and outs of covered bonds, their extra protective measures for bondholders, and the different types of covered bonds and their respective default provisions.
  • Credit Enhancements: Peel back the layers of credit enhancements in asset-backed securities to understand how they protect investors from potential losses.
  • Non-Mortgage Asset-Backed Securities: Get to grips with the nuances between amortising and non-amortising loans, and dive into the specifics of auto loan-backed securities and credit card receivable-backed securities.
  • Collateralised Debt Obligations: Understand the composition of collateral debt obligations (CDOs) and the tiered structure of CDOs, including how returns are generated for different tranches.

14. Mortgage-Backed Security (MBS) Instrument and Market Features

Unlock the intricacies of Mortgage-Backed Securities (MBS), where you’ll learn about residential loans, dive into the realm of residential and commercial MBS, and understand their unique market and instrument features. This lesson is your roadmap to mastering MBS fundamentals, from mortgage loans to securitization processes.

  • Residential Mortgage Loans: Understand the fundamentals, key characteristics and types of residential mortgage loans including prime and subprime.
  • Residential Mortgage-Backed Securities: Explore the different sectors of Residential Mortgage-Backed Securities (RMBS), the role of prepayment risk, and how risk management techniques make non-agency RMBS attractive to investors.
  • Commercial Mortgage-Backed Securities: Learn the distinct differences between Commercial Mortgage-Backed Securities (CMBS) and residential MBS, with an emphasis on credit risk analysis and CMBS-specific features.

Wrapping Up: Mastering Fixed Income for CFA Level 1

And that’s a wrap – a comprehensive overview of the Fixed Income topic in the CFA Level 1 exam! Remember to stay curious, practice plenty of questions, and enjoy the fascinating world of fixed income securities. After all, who said bonding with bonds couldn’t be an exciting journey? Good luck, and may your newfound fixed income expertise lead you to CFA success!