CFA® Fixed Income
Summary, Syllabus, Topics, and Sample Questions (L1, L2, L3)

What to Expect in CFA Level 1 Fixed Income?

On the CFA Institute’s Level 1 exam, Fixed Income is among the top three most heavily weighted topics, along with Financial Statement Analysis and Ethics.

Candidates are taught to define fixed income securities and calculate and interpret their associated features. The material covers securitization, the fundamentals of credit risk, and the influence of interest rates on bond returns.

Exam Weighting

The CFA Fixed Income topic has a weight of 10%-12% of the total exam content, so that approximately 18-21 of the 180 CFA Level 1 exam questions focus on this topic.

Level 1 Fixed Income 2023 Syllabus, Readings, and Changes

The CFA Level 1 curriculum includes 73 readings for 2023, with 6 on Fixed Income (8.2% of the total curriculum). For the 2023 curriculum, there are no changes to the Fixed Income learning modules (all were updated in 2022).

The weight of the Fixed Income section increased from 2018 to 2019. Since 2021, the weight has fluctuated between 10-12% of the total exam content.

Fixed Income Securities: Defining Elements

Fixed income securities allow organizations to borrow from investors in return for future interest payments and the return of principal. Based on total market value, these instruments are the most widespread means of raising capital around the world. For this reason, financial analysts with a comprehensive understanding of Fixed Income concepts will have an edge over their peers.

• Candidates will learn about the three important factors concerning fixed Income security investment: the bond’s features, considerations regarding contractual agreements between bondholder and issuer, and contingency provisions that might affect cash flows.

Fixed Income Markets: Issuance, Trading, and Funding

Global Fixed Income markets include both publicly traded securities and non-publicly traded loans. These markets typically attract less attention despite being three times larger than global equity markets.

• The learning module presents a summary of global fixed income markets and their major players.
• Candidates will be introduced to fixed income indexes and fixed income trading in secondary markets.

Introduction to Fixed Income Valuation

Pension funds, mutual funds, insurance companies, sovereign wealth funds, and retirees are all typical investors in fixed income securities. Proper valuation of these securities is critical for both the institutions and individuals who invest in them and the businesses and governments that rely on them for financing.

• The learning module covers the necessary concepts and techniques for valuing fixed-rate bonds, floating-rate notes, and money market instruments.
• Candidates will also learn to analyze yield curves and yield spreads as they relate to maturity and risk, respectively.

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Introduction to Asset-Backed Securities

Many kinds of assets generate cash flows for their investors, such as mortgages, auto loans, student loans, bank loans, etc. When those cash flows are securitized, they pass through an entity that repackages them as fixed income securities, and their cash flows become the basis of that asset’s value. Special entities issue these securities as asset-backed securities (ABS).

• Candidates will be introduced to the benefits of securitization for investors, issuers, economies, and financial markets.
• The learning module also explores the various characteristics of different ABS types and their associated risks.

Understanding Fixed Income Risk and Return

The principles used to evaluate fixed income risk and returns extend to the many financial assets and liabilities that financial analysts will encounter throughout their careers. Specific topics include fixed-rate bond returns, duration and convexity, the price value of basis point (PVBP), and various types of risks.

• The learning module introduces bond duration and convexity as they relate to interest rate risk measures and credit and liquidity risks.
• Candidates will also learn to use statistical methods to establish empirical estimates using historical data.

Fundamentals of Credit Analysis

The debt market is critical to funding the operations of companies and governments and facilitating economic growth in general. This means that credit analysis is vital for capital allocation. Financial analysts must understand how to assess credit risk, and to price and reprice it as risk factors evolve.

• The learning module introduces the core concepts of credit risks (e.g., default probability, loss severity) and credit-related risks (e.g., liquidity risk, spread risk, credit migration risk).
• Candidates will also learn about the relationship between credit risk and the capital structure of the firm.

CFA Fixed Income Level 1 Sample Questions and Answers

The sample questions are typical of the probing multiple-choice questions on the CFA L1 exam. During the exam, you have about 90 seconds to read and answer each question, carefully designed to test knowledge from the CFA Curriculum. UWorld’s question bank is built to expose you to exam-like questions and illustrate and explain the concepts tested thoroughly.

• Question 1
• Question 2
• Question 3

An analyst has gathered the following information on zero-coupon government bond yields:

Maturity	Spot Rate
1 year	2.42%
2 years	3.05%
3 years	3.48%
4 years	3.65%

If the rates are based on a periodicity of 1, the one-year forward rate 2 years in the future (2y1y) is closest to:

1. 3.72%
2. 4.16%
3. 4.35%

Submit

• Explanation

A forward rate (or implied forward rate [IFR]) is a future period interest rate.  Forward rates are not expectations of future spot rates; instead, they are future interest rates that reflect the difference between spot rates of different maturities (ie, tenors), based on the assumption that investment strategies covering the same time horizon and carrying equivalent risk should have the same return.  In effect, forward rates are the breakeven reinvestment rates that produce that result.  Arbitrage-free pricing enforces the consistency of forward rates with spot rate differences.

In this scenario, equal amounts invested in a strategy today should have the same future value at the end of 3 years.  To answer this question, two investment strategies can be compared as follows:

• Buy a three-year zero-coupon bond and hold it to maturity (ie, right side of the first equation above).
• Buy a two-year zero-coupon bond and hold it to maturity; at maturity, reinvest the proceeds in a one-year zero-coupon bond (ie, left side of the first equation above).

These two strategies are illustrated on the following timeline:

The IFR for the one-year forward rate starting 2 years in the future (IFR_2,3−2) is calculated as follows:

(Choice A)  3.72% results from incorrectly calculating the IFR as [(1 + Three-year spot rate)³ − 1] / 2.

(Choice B)  4.16% is the one-year forward rate starting 3 years in the future.

Things to remember:
A forward rate is a future period interest rate that reflects the difference between spot rates of different tenors.  In effect, forward rates are breakeven reinvestment rates that result in two investment strategies of equivalent risk, covering the same time horizon and earning the same return.

A two-year floating-rate note pays three-month Libor plus 15 basis points. The floater is priced at 99.60 per 100 par value, three-month Libor is currently 1.45%, and the coupon reset today. Assuming a 30/360 day-count convention and quarterly coupon payments, the discount margin in basis points (bps) is closest to:

1. 35 bps
2. 40 bps
3. 45 bps

Submit

• Explanation

A floating-rate note (FRN) is a debt instrument with an interest rate that resets periodically, so that the interest rate and payments are “floating” and not fixed.  The interest rate is based on a reference rate, such as LIBOR, plus a quoted margin, which compensates the investor for the credit risk of the issuer.

The price of an FRN is its discounted future payments, where the discount factor is based on the reference rate plus a discount margin.  The discount margin represents the market’s required spread to price the FRN at par on the reset date.

To solve for the discount margin, first calculate the discount factor and then use that to derive the discount margin.

1. Calculate the discount factor (using a financial calculator):

2. Use the discount factor to find the discount margin:
   

(Choice B)  40 bps is the difference between the market price and par value, not the discount margin.

(Choice C)  45 bps is the periodic discount factor, not the discount margin.  The periodic discount factor equals the sum of the reference rate and the discount margin (180 bps) divided by the number of periods per year (4).

Things to remember:
A floating-rate note (FRN) is a debt instrument with an interest rate that resets periodically and is based on a reference rate, such as LIBOR, plus a quoted margin.  The price of an FRN is its discounted future payments, where the discount factor is based on the reference rate plus a discount margin that reflects the market’s required return.

A coupon bond’s Macaulay duration is most accurately described as the holding period over which:

1. the value of cash flows received equal the cost of buying the bond.
2. changes in reinvestment income offset changes in the bond’s price.
3. the bond earns a risk-free return if hedged by shorting a government bond.

Submit

• Explanation

Noncallable coupon bonds contain two types of interest rate risk: reinvestment risk and price risk.  Reinvestment risk dominates in the long run and price risk dominates in the short run.  Logically, somewhere in between the short run and the long run, there should be a balance point.  That point is the Macaulay duration: the holding period to the point where changes in reinvestment income and changes in price offset one another exactly.

• Interest rates increase: additional reinvestment income and bond price decreases
• Interest rates decrease: reduced reinvestment income and bond price increases

No matter the direction, the impact of a rate change is positive for one source of return, but negative for the other.  In the short run, price risk dominates.  Interest rate changes affect bond prices immediately.  In the long run, reinvestment risk dominates since its impact builds over time as more coupons are reinvested.  A bond’s Macaulay duration is the holding period over which those risks balance each other.

(Choice A)  Market price equals the present value of the coupon and principal, so a bond must be held to maturity to receive cash flows with a value equal to the cost of the bond.  Since Macaulay duration is the present value weighted average time of the cash flows, a coupon bond’s Macaulay duration is shorter than its time to maturity.

(Choice C)  Although it is a type of hedge, the strategy is not riskless and therefore does not lock in a risk-free rate of return.

Things to remember:
The Macaulay duration is the holding period of a bond to the point where changes in reinvestment income and changes in price offset one another exactly.

What to Expect in CFA Level 2 Fixed Income?

The CFA Level 2 Fixed Income is one of the most heavily weighted topics on the exam. The material introduces traditional and modern theories regarding the shape of the yield curve and the fundamental relationships underpinning its composition. Candidates will study valuation methods used to value bonds with embedded options and various credit analysis concepts.

Exam Weight

The CFA Fixed Income topic has a weight of 10%-15% of the total exam content, so that approximately 8-12 questions or 2-3 item sets on the CFA Level 2 exam focus on this topic.

Level 2 Fixed Income Syllabus, Readings, and Changes

The CFA Level 2 curriculum includes 49 total learning modules for 2023, with five centered on Fixed Income (10% of the total curriculum). There have been no changes to the L2 Fixed Income curriculum in 2023, except for minor updates.

The weight of the Fixed Income exam section has remained at a consistent 10-15% since 2019.

The Term Structure and Interest Rate Dynamics

Interest rates act to both influence and measure the economy. Quantifying interest rate risk is an important skill for risk managers, and understanding the determinants of interest rates is important for issuers of and investors in fixed income securities.

• The learning module explains spot rates and forward rates and their influence on the yield curve shape.
• Candidates will build on this information to understand how forward rates influence the yield-to-maturity and expected bond returns.

The Arbitrage-Free Valuation Framework

Valuing fixed income securities, derivatives, and other financial assets is predicated on the idea that market prices adjust until arbitrage opportunities expire.

• The learning module introduces concepts and techniques for no-arbitrage valuation of Fixed Income securities.
• This includes discussions of the binomial interest rate tree and a Monte Carlo forward-rate simulation.

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Valuation and Analysis of Bonds with Embedded Options

The value of embedded options is typically contingent on interest rates. This makes bond valuation more complex when a bond has one or more embedded options. Bond issuers and investors must understand how various embedded options influence bond values and their sensitivity to interest rate changes.

• The learning module introduces a summary of different types of embedded options before exploring bonds that include a call or put provision.
• Candidates will also learn about how option-adjusted spreads are used to value risky callable and putable bonds.

Credit Analysis Models

Credit analysis models rely on inputs such as exposure to default loss, the loss given default, and the probability of default. These models are an important part of valuing corporate and government bonds.

• Candidates are introduced to structural and reduced-form credit analysis models.
• The learning module also covers the arbitrage-free framework and compares the credit analysis for securitized debt with that of corporate bonds.

Credit Default Swaps

A credit default swap is a financial contract between two parties that enables an investor to “swap” or offset credit risk with another investor for a defined period of time. These derivative instruments are broadly used internationally.

• The learning module classifies these instruments and explores the fundamental concepts behind them.
• Candidates will learn about the elements associated with their valuation, pricing, and applications.

CFA Fixed Income Level 2 Sample Questions and Answers

The sample questions here are typical of the L2 exam’s complexity and depth: formatted as item sets, with a vignette to deliver a scenario that tests the CFA L2 Curriculum. (On the actual exam, each vignette applies to four questions; we’ve thrown in a couple extra to get a bit more learning in). And be sure to review the illustrated explanations we’ve provided for each question: UWorld’s question bank is designed to expose you to exam-like questions and explain the concepts tested thoroughly.

What to Expect in CFA Level 3 Fixed Income?

The CFA Level 3 Fixed Income topic is the second most heavily weighted topic on the exam, with a weight of 15-20%. The two study sessions discuss the role played by fixed income securities in portfolios and introduce fixed income mandates before revisiting the yield curve and its association with fixed income portfolios.

Exam Weighting

The CFA Fixed Income Portfolio Management topic has a weight of 15%-20% of the total exam content, meaning that approximately 12-16 questions or 3-4 items sets and essay vignettes on the CFA Level 3 multiple choice exam questions focus on this topic.

Level 3 Fixed Income Syllabus, Readings, and Changes

The CFA Level 3 curriculum includes 35 total readings for 2023., with 4 (11.4%) of these readings on Fixed Income (readings 11-14). The syllabus is divided into the following two study sessions:

Due to the latest transition in Level 3 exam windows —despite other major CFA curriculum changes in levels 1 and 2—CFA Institute has decided to freeze changes in CFA Level 3. This means that the CFA Level 3 curriculum will remain the same as it was in 2022.

The weight of the Fixed Income topic has remained consistent since 2018.

Overview of Fixed Income Portfolio Management

Fixed income instruments run the gamut from publicly traded securities to non-publicly traded instruments. Investors use these instruments to generate regular income from their investments until their capital is returned at a predetermined date.

• The reading discussed the various roles of fixed income securities in portfolios, fixed income mandates, and bond market liquidity.
• Candidates will also cover portfolio measures, instruments, and vehicles used in fixed income portfolio management.

Liability-Driven and Index-Based Strategies

Passive fixed income investment strategies go beyond buy and hold strategies. Bond portfolios can be routinely rebalanced using strategies like immunization and indexation. The reading covers such strategies alongside strategies for liability-driven investing.

• Candidates will learn how to develop and structure fixed income portfolios with assets and liabilities in mind.

Yield Curve Strategies

Active fixed income management involves deviating from the primary risk factors associated with an index. To generate excess returns, analysts must assess the yield curve and develop a portfolio with interest rates in mind.

• The reading primarily covers fixed income yield curve management strategies to exceed the returns of a benchmark index due to yield curve changes.

Fixed Income Active Management: Credit Strategies

The reading emphasizes credit spreads and how to quantify the effect of spread changes on portfolio value. Candidates will review other expected fixed income return components and learn about credit spread measures for fixed- and floating-rate bonds.