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Study Notes for CFA® Level II – Fixed Income – offered by AnalystPrep

12 Aug 2021

Reading 28: The Term Structure and Interest Rate Dynamics

-a. Describe relationships among spot rates, forward rates, yield to maturity, expected and realized returns on bonds, and the shape of the yield curve;

-b. Describe how zero-coupon rates (spot rates) may be obtained from the par curve by bootstrapping;

-c. Describe the assumptions concerning the evolution of spot rates in relation to forward rates implicit in active bond portfolio management;

-d. Describe the strategy of riding the yield curve;

-e. Explain the swap rate curve and why and how market participants use it in valuation;

-f. Calculate and interpret the swap spread for a given maturity;

-g. Describe short-term interest rate spreads used to gauge economy-wide credit risk and liquidity risk;

-h. Explain traditional theories of the term structure of interest rates and describe each theory’s implications for forward rates and the shape of the yield curve;

-i. Explain how a bond’s exposure to each of the factors driving the yield curve can be measured and how these exposures can be used to manage yield curve risks;

-j. Explain the maturity structure of yield volatilities and their effect on price volatility;

-k. Explain how key economic factors are used to establish a view on benchmark rates, spreads, and yield curve changes.

Reading 29: The Arbitrage-Free Valuation Framework

-a. Explain what is meant by arbitrage-free valuation of a fixed-income instrument;

-b. Calculate the arbitrage-free value of an option-free, fixed-rate coupon bond;

-c. Describe a binomial interest rate tree framework;

-d. Describe the process of calibrating a binomial interest rate tree to match a specific term structure;

-e. Describe the backward induction valuation methodology and calculate the value of a fixed-income instrument given its cash flow at each node;

-f. Compare pricing using the zero-coupon yield curve with pricing using an arbitrage-free binomial lattice;

-g. Describe pathwise valuation in a binomial interest rate framework and calculate the value of a fixed income instrument given its cash flows along each path;

-h. Describe a Monte Carlo forward-rate simulation and its application;

-i. Describe time structure models and how they are used;

Reading 30: Valuation and Analysis of Bonds with Embedded Options

-a. Describe fixed-income securities with embedded options;

-b. Explain the relationships between the values of a callable or putable bond, the underlying option free (straight) bond, and the embedded option;

-c. Describe how the arbitrage-free framework can be used to value a bond with embedded options;

-d. Explain how interest rate volatility affects the value of a callable or putable bond;

-e. Explain how changes in the level and shape of the yield curve affect the value of a callable or putable bond;

-f. Calculate the value of a callable or putable bond from an interest rate tree;

-g. Explain the calculation and use of option-adjusted spreads;

-h. Explain how interest rate volatility affects option-adjusted spreads;

-i. Calculate and interpret the effective duration of a callable or putable bond;

-j. Compare effective durations of callable, putable, and straight bonds;

-k. Describe the use of one-sided durations and key rate durations to evaluate the interest rate sensitivity of bonds with embedded options;

-l. Compare effective convexities of callable, putable, and straight bonds;

-m. Calculate the value of a capped or floored floating-rate bond;

-n. Describe defining features of a convertible bond;

-o. Calculate and interpret the components of a convertible bond’s value;

-p. Describe how a convertible bond is valued in an arbitrage-free framework;

–q. Compare the risk-return characteristics of a convertible bond with the risk-return characteristics of a straight bond and the underlying common stock.

Reading 31: Credit Analysis Models

-a. Explain expected exposure, the loss given default, the probability of default, and the credit valuation adjustment;

-b. Explain credit scores and credit ratings;

-c. Calculate the expected return on a bond given transition in its credit rating;

-d. Explain structural and reduced-form models of corporate credit risk, including assumptions, strengths, and weaknesses;

-e. Calculate the value of a bond and its credit spread, given assumptions about the credit risk parameters;

-f. Interpret changes in a credit spread;

-g. Explain the determinants of the term structure of credit spreads and interpret a term structure of credit spreads;

-h. Compare the credit analysis required for securitized debt to the credit analysis of corporate debt;

Reading 32: Credit Default Swaps

-a. Describe credit default swaps (CDS), single-name and index CDS, and the parameters that define a given CDS product;

-b. Describe credit events and settlement protocols with respect to CDS;

-c. Explain the principles underlying and factors that influence the market’s pricing of CDS;

-d. Describe the use of CDS to manage credit exposures and to express views regarding changes in shape and level of the credit curve;

-e. Describe the use of CDS to take advantage of valuation disparities among different markets, such as bonds, loans, equities, and equity-linked instruments;

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