Fixed-Income Securities and Money Market Instruments
What this domain tests
Pricing, yield measurement and interest-rate risk on bonds, plus the short-term instruments that make up the money market. Expect price-yield reasoning, duration-based price change, and discount-versus-true-yield conversions on T-bills.
Core rules
- Bond price is the present value of coupons plus principal, discounted at the yield. Price and yield move inversely.
- Coupon > yield → premium; coupon < yield → discount; coupon = yield → par.
- Accrued interest is owed by the buyer to the seller; clean price + accrued interest = dirty (settlement) price.
- Modified duration approximates percentage price change: %ΔP ≈ −D_mod × Δy. Convexity corrects the estimate for larger yield moves.
- Term-structure theories: expectations, liquidity preference (upward bias), market segmentation.
- Money market instruments: T-bills, commercial paper, bankers' acceptances, repo, all maturing in one year or less.
Worked example
A 91-day T-bill with a $1,000,000 face value is quoted at a 4.50% discount yield.
- Price = Face × (1 − d × days/365) = 1,000,000 × (1 − 0.045 × 91/365) = 1,000,000 × (1 − 0.011219) = $988,781
- True yield = (1,000,000 − 988,781) / 988,781 × 365/91 = 0.011346 × 4.010989 = 4.55% The true (investment) yield always exceeds the quoted discount yield because the discount is taken from face value but the investor's actual outlay is the lower price.
Traps
- Applying the discount-yield formula using the price instead of face value in the denominator.
- Quoting clean price when the question asks for settlement amount.
- Forgetting that duration falls as the coupon rises or the term shortens.
- Treating a bond's yield as its coupon rate.
Key points
- Bond prices and yields move inversely; duration measures sensitivity.
- %ΔP ≈ −modified duration × Δy, refined by convexity.
- Settlement price = clean price + accrued interest.
- True yield on a T-bill exceeds the quoted discount yield.
- Discount yield uses face value in the denominator; true yield uses price.