Debt securities and fixed income products
What this domain tests
Expect questions on how bonds are priced and quoted, what the investor actually pays, how credit and interest-rate risk are measured, and how structural features change the payoff.
Core concepts
- Price and yield move inversely. A bond trading above par has a coupon above its yield; below par, the reverse.
- The clean price is quoted; the settlement amount is the dirty price = clean price + accrued interest, calculated on the day-count convention (e.g. Actual/365 or 30/360).
- Duration measures price sensitivity to yield; modified duration approximates the percentage price change for a 1% yield move; convexity corrects the approximation for larger moves.
- Credit spread compensates for issuer risk; ratings are opinions, not guarantees. Seniority, security, covenants and put/call features all change recovery and price.
- Structures to know: callable and puttable bonds, convertibles, perpetuals and AT1 instruments with trigger/extension features, medium-term note programmes, and settlement through CMU or international clearing systems.
Worked example
A 3-year bond, face HK$100, 5% annual coupon, priced to yield 6%. Price = 5/1.06 + 5/1.06² + 105/1.06³ = 4.72 + 4.45 + 88.16 = HK$97.33. Because the yield exceeds the coupon, the bond trades at a discount. If settlement is mid-coupon, the buyer pays 97.33 plus accrued interest.
Traps that cost marks
Quoting a price when asked for a yield (or the reverse); ignoring accrued interest in the settlement amount; assuming a high rating removes credit risk; and treating a callable bond as if it had the same duration as a straight bond.