Fixed Income Securities and Money Market Instruments
What a candidate must understand
A bond is a loan: the issuer pays coupons and repays principal at maturity. Know price–yield inverse relationship, clean vs dirty price (dirty includes accrued interest), yield to maturity, current yield, and duration as a measure of price sensitivity (modified duration ≈ percentage price change per 1% yield move). Understand credit risk (default, downgrade), interest-rate risk, reinvestment risk and inflation risk. Cover government, agency, corporate and supranational issuers, senior vs subordinated debt, secured vs unsecured, callable and puttable features, and floating-rate notes. Money market instruments mature in one year or less and are typically discount instruments: Treasury bills, commercial paper, certificates of deposit, banker's acceptances, repurchase agreements. Know that money market funds aim for capital preservation and liquidity.
Traps that appear in questions
- Thinking a bond's price rises with yields; it falls.
- Ignoring accrued interest when computing the cash a buyer pays.
- Assuming a higher coupon means lower interest-rate risk; longer duration means more risk regardless of coupon size.
- Confusing a call feature (issuer's option, bad for investors) with a put feature (investor's option, protective).
- Treating commercial paper as long-term funding.
Worked example / rule of thumb
A bond with modified duration 5 loses roughly 5% if yields rise 1%. Rule of thumb: longer maturity, lower coupon, lower yield = higher duration = greater price sensitivity. Money market instruments are quoted on a discount basis, so the return exceeds the simple discount rate.