CFA CFA Level 1 Question of the Week – Fixed Income

Question of the Week – Fixed Income

  • This topic has 9 replies, 6 voices, and was last updated Jan-18 by AdaptPrep.
  • Author
    Posts
    • Up
      4

      Keisha is looking to avoid purchasing power risk as much as possible. She should consider investing in which type of security?

      • TIPS
      • Floats
      • Bullet bonds
    • Up
      6

      AAARGH. @PassedTense‌ I thought TIPS have purchasing power risk!

    • Up
      4

      Treasury Inflation-Protected
      Securities (TIPS)
      are designed to protect the purchaser from inflation, by
      paying out a coupon tied to an inflation index.

      Floats protect against interest rate risk, but not purchasing power risk.

      Bullet bonds protect against the risk of the bond being called as they are not callable prior to maturity.

    • Up
      3

      Thanks @jak5189‌!

    • Up
      3

      yep @jak5198! in a nutshell FRNs have less interest rate risk (risk of bond price volatility due to changing market interest rates) because the coupon resets periodically in line with market rates. (so basically you’re right :))

    • Up
      3

      This question is just a wordy
      way of asking which investment protects against inflation. I suppose the tricky
      part is not overthinking it.

    • Up
      2

      Woo! I got it right. 

    • Up
      2

      @jak5189, i believe you are right. FRN (floating rate notes) have less interest rate risk because the coupon rate is reset periodically to be brought in line with current market yields. so from the rate of the investor, it compensates them if market rates increase and from the perspective of the issuer, it protects them in case rates decrease 

    • Up
      2

      @Simply_complex2, if I am understanding an increase in market interest rates will cause the coupon rate to adjust up to the new market rate to compensate investors for the depreciation in the price of the bond? The compensation is in the form of a higher reinvestment rate? And for the issuer, the decrease in interest rates causes the coupon rate to adjust downward, which allows the issuer to pay out less to the investor. Is that the logic??

    • Up
      1

      @HairyFairy, TIPS – Treasury Inflation Protected Securities; Inflation = purchasing power erosion, therefore TIPS would be the proper security for protection. That’s how I remember it. Hopefully that helps 🙂

      @PassedTense, FRNs protect interest rate risk correct? I am a little unclear on their purpose in risk protection.

Viewing 9 reply threads
  • You must be logged in to reply to this topic.