Fixed Income and Money Market Instruments
This domain tests pricing logic: the inverse relationship between bond prices and yields, the meaning of duration and credit spread, and the cash-flow maths of short-dated instruments.
Core rules
A bond's price is the present value of its coupons and principal at the market yield; when yields rise, prices fall. Duration measures price sensitivity to yield: modified duration approximates the percentage price change for a small yield change. Credit spread compensates for default and liquidity risk and widens when an issuer deteriorates. The yield curve reflects expectations and term premium. Money market instruments such as treasury bills, commercial paper, certificates of deposit and repos mature within a year, are quoted on a discount or add-on basis, and carry reinvestment and rollover risk.
Worked example
A bond has modified duration 5.0 and yields rise by 50 basis points. Approximate price change = -5.0 x 0.005 = -0.025, or -2.5%. On 1,000,000 nominal the value falls by about 25,000. Convexity makes the actual fall slightly smaller for a plain bond, so treat the duration estimate as a first approximation.
Traps that cost marks
Confusing coupon with yield; assuming a higher coupon means a safer bond; treating a short maturity as free of credit risk; mixing discount-rate and add-on yield quotes on money market instruments; forgetting accrued interest when settling a bond trade.