Study Session #15
Learning Outcome Statements
(Last revised 12/12/04)

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1. A. “Features of Fixed Income Securities”
a) explain the purposes of a bond’s indenture and describe affirmative and negative covenants;
b) describe the basic features of a bond (e.g., maturity, coupon rate, par value, provisions for paying
off bonds, currency denomination, options granted to the issuer or investor);
c) describe the various coupon rate structures (e.g., zero-coupon bonds, step-up notes, deferred
coupon bonds, floating-rate securities);
d) describe the structure of floating-rate securities (i.e., the coupon formula and caps and floors)
e) define accrued interest, full price, and clean price;
f) explain the provisions for early retirement of debt, including call and refunding provisions,
prepayment options, and sinking fund provisions;
g) differentiate between a regular redemption price and a special redemption price;
h) explain the importance of options embedded in a bond issue and indicate whether such options
benefit the issuer or the bondholder;
i) describe the common methods used by institutional investors in the bond market to finance the
purchase of a security (i.e., margin buying and repurchase agreements).
B. “Risks Associated with Investing in Bonds”
a) explain the risks associated with investing in bonds (e.g., interest rate risk, call and prepayment risk,
yield curve risk, reinvestment risk, credit risk, liquidity risk, exchange-rate risk, volatility risk, inflation
risk, and event risk);
b) identify the relationship among a bond’s coupon rate, the yield required by the market, and the
bond’s price relative to par value (i.e., discount, premium, or equal to par);
c) explain how features of a bond (e.g., maturity, coupon, and embedded options) affect the bond’s
interest rate risk;
d) identify the relationship among the price of a callable bond, the price of an option-free bond, and
the price of the embedded call option;
e) explain how the market yield environment affects the interest rate risk of a bond;
f) explain the interest rate risk of a floating-rate security and why such a security’s price may differ
from par value;
g) interpret the meaning of the duration of a bond;
h) compute the duration of a bond, given the bond’s change in price when interest rates change;
i) compute the approximate percentage price change of a bond, given the bond’s duration;
j) compute the approximate new price of a bond, given the bond’s duration and new yield level;
k) explain why duration does not account for yield curve risk for a portfolio of bonds;
l) explain the disadvantages of a callable and prepayable security to an investor;
m) identify the factors that affect the reinvestment risk of a security;
n) Explain why prepayable amortizing securities expose investors to greater reinvestment risk than
nonamortizing securities;
o) describe the various forms of credit risk (i.e., default risk, credit spread risk, downgrade risk);
p) explain why liquidity risk is important to investors even if they expect to hold a security to the
maturity date;
q) describe the exchange rate risk an investor faces when a bond makes payments in a foreign
currency;
r) describe inflation risk and explain why it exists;

s) explain how yield volatility affects the price of a bond with an embedded option and how changes
in volatility affect the value of a callable bond and a putable bond;
t) describe the various forms of event risk (e.g., natural catastrophe, corporate takeover/restructuring,
regulatory risk, and political risk) and he components of sovereign risk.
C. “Overview of Bond Sectors and Instruments”
a) describe different types of international bonds (eg. Foreign bonds, Eurobonds, global bonds,
sovereign debt);
b) describe the types of securities issued by the US Department of the Treasury (eg. Bills, notes,
bonds, and inflation protected securities;
c) differentiate between on-the-run and off-the-run Treasury securities;
d) discuss how stripped Treasury securities are created and distinguish between coupon strips and
principal strips;
e) describe a mortgage-backed security and explain the cash flows for a mortgage-backed security;
f) define prepayments, and explain prepayment risk;
g) describe the types and characteristics of securities issued by federal agencies (including mortgage
passthroughs and collateralized mortgage obligations);
h) state the motivation for creating a collateralized mortgage obligation;
i) describe the types of securities issued by municipalities in the United States;
j) distinguish between general obligation bonds and revenue bonds;
k) describe insured bonds and prerefunded bonds;
l) summarize the bankruptcy process and bondholder rights;
m) explain the factors considered by rating agencies in assigning a credit rating to a corporate debt
instrument;
n) describe secured debt, unsecured debt, and credit enhancements for corporate bonds;
o) distinguish between a corporate bond and a medium-term note;
p) describe commercial paper and distinguish between directly-placed paper and dealer-placed paper;
q) describe an asset-backed security;
r) describe the role of a special purpose vehicle in an asset-backed securities transaction;
s) state the motivation for a corporation to issue an asset-backed security;
t) describe the types of external credit enhancements for asset-backed securities;
D. “Understanding Yield Spreads”
a) identify the interest rate policy tools available to a central bank (such as the U.S. Federal Reserve);
b) describe a yield curve and different yield curve shapes observed;
c) explain the basic thories of the term structure of interest rates (ie. Pure expectations theory,
liquidity preference theory, and market segmentation theory);
d) describe the implications of each theory for the shape of the yield curve;e) explain the different
types of yield spread measures (e.g., absolute yield spread, relative yield spread, yield ratio) and
compute yield spread measures given the yield for two securities;
f) explain why investors may find a relative yield spread to be a better measure of yield spread than
the absolute yield spread;
g) distinguish between an intermarket and intramarket sector spread;
h) describe a credit spread and discuss the suggested relationship between credit spreads and the
economic well being of the economy;
i) identify how embedded options affect yield spreads;
j) explain how the liquidity of an issue affects its yield spread relative to Treasury securities and
relative to other issues that are comparable in all other ways except for liquidity;
k) describe the relationship that is argued to exist among the size of an issue, liquidity, and yield
spread;
l) compute the after-tax yield of a taxable security and the tax-equivalent yield of a tax-exempt
security.

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