Study Session #16
Learning Outcome Statements
(Last revised 12/01/04)

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1. A. “Introduction to the Valuation of Fixed Income Securities”
A. Describe the fundamental principles of bond valuation.
B. Identify the types of bonds for which estimating the expected cash flow is difficult and
explain the problems encountered when estimating the cash flows for these bonds.
C. Determine the appropriate interest rates to use in discounting a bond’s cash flows.
D. Compute the value of a bond, given the expected cash flows and the appropriate
discount rates.
E. Explain how the value of a bond changes if the discount rate increases or decreases and
compute the change in value that is attributable to the rate change.
F. Explain how the price of a bond changes as the bond approaches its maturity date and
compute the change in value that is attributable to the passage of time.
G. Compute the value of a zero-coupon bond.
H. Explain the arbitrage-free valuation approach and the market process that forces the
price of a bond towards its arbitrage-free value.
I. Determine whether a bond is undervalued or overvalued, given the bond’s cash flows,
appropriate spot rates or yield to maturity, and current market price.
J. Explain how a dealer can generate an arbitrage profit.
B. “Yield Measures, Spot Rates, and Forward Rates”
A. Explain the sources of return from investing in a bond (i.e., coupon interest payments,
capital gain/loss, and reinvestment income).
B. Compute the traditional yield measures for fixed-rate bonds (e.g., current yield, yield to
maturity, yield to first call, yield to first par call date, yield to put, yield to worst, cash
flow yield).
C. Explain the assumptions underlying traditional yield measures and the limitations of the
traditional yield measures.
D. Explain the importance of reinvestment income in generating the yield computed at the
time of purchase, and calculate the amount of income required to generate that yield.
E. Discuss the factors that affect reinvestment risks.
F. Compute the bond equivalent yield of an annual-pay bond and compute the annual-pay
yield of a semiannual-pay bond.
G. Compute the value of a bond using spot rates.
H. Compute the theoretical Treasury spot rate curve, using the method of bootstrapping
and given the Treasury par yield curve.
I. Explain the limitations of the nominal spread.
J. Differentiate among the nominal spread, the zero-volatility spread, and the optionadjusted
spread for a bond with an embedded option, and explain the option cost.
K. Explain a forward rate and compute the value of a bond using forward rates.
L. Explain and illustrate the relationship between short-term forward rates and spot rates.
M. Compute spot rates from forward rates and forward rates from spot rates.
C. “Introduction to the Measurement of Interest Rate Risk”
A. Distinguish between the full valuation approach (the scenario analysis approach) and the
duration/convexity approach for measuring interest rate risk, and explain the advantage
of using the full valuation approach.

B. Compute the interest rate risk exposure of a bond position or of a bond portfolio, given
a change in interest rates.
C. Demonstrate the price volatility characteristics for option-free bonds when interest rates
change (including the concept of “positive convexity”).
D. Demonstrate the price volatility characteristics of callable bonds and prepayable
securities when interest rates change (including the concept of “negative convexity”).
E. Describe the price volatility characteristics of putable bonds.
F. Compute the effective duration of a bond, given information about how the bond’s
price will increase and decrease for a given change in interest rates.
G. Compute the approximate percentage price change for a bond, given the bond’s duration
and a specified change in yield.
H. Distinguish among modified duration, effective (or option-adjusted) duration, and
Macaulay duration.
I. Explain why effective duration, rather than modified duration or Macaulay, should be
used to measure the interest rate risk for bonds with embedded options.
J. Describe why duration is best interpreted as a measure of a bond’s or portfolio’s
sensitivity to changes in interest rates.
K. Compute the duration of a portfolio, given the duration of the bonds comprising the
portfolio.
L. Explain the limitations of the portfolio duration measure.
M. Discuss the convexity measure of a bond.
N. Estimate a bond’s percentage price change, given the bond’s duration and convexity
measure and a specified change in interest rates.
O. Differentiate between modified convexity and effective convexity.
P. Compute the price value of a basis point (PVBP) and explain its relationship to duration.

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