Overview
Fixed Income is 11-14% of the CFA Level 1 exam, one of the three heaviest topics and a frequent source of difficulty alongside options. It has four areas. Instruments and issuance cover the features of fixed-income securities (issuer, maturity, coupon, embedded options), the types of bonds (government, corporate, securitized) and how bonds are issued and traded. Pricing and yields cover valuing a bond as the present value of its cash flows, the inverse price-yield relationship, and the yield measures (yield to maturity, current yield, spot and forward rates, the term structure). Interest rate risk covers duration (the sensitivity of price to yield changes) and convexity (the curvature of that relationship). Credit analysis and securitized products cover assessing default risk, credit spreads and ratings, and asset-backed and mortgage-backed securities.
The exam rewards understanding bond features, pricing bonds and the inverse price-yield relationship, computing and interpreting duration and convexity, and assessing credit risk. It uses the time value of money heavily.
How it's tested
CFA Level 1 Fixed Income questions test bond pricing, a yield measure, interest rate risk, or credit analysis. CFA Level 1 questions are multiple choice with three options, mixing concept recall with calculations, so read for the specific concept or formula being tested and work the computation carefully where required.
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Price and yield
A bond situation is described, and you price the bond or apply the price-yield relationship or a yield measure.
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Interest rate risk
A rate-change situation is described, and you apply duration and convexity.
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Credit and structure
A credit or securitization situation is described, and you assess risk or identify the structure.
Market interest rates rise, and an investor holds a long-maturity, low-coupon bond, asking how its price will react. Bond prices move inversely to yields, and longer-maturity, lower-coupon bonds have higher duration, so they are more sensitive to rate changes. The bond's price will fall, and by more than a shorter or higher-coupon bond, which is the interest-rate-risk conclusion the exam expects, combining the inverse relationship with the duration effect.
Topic areas 4
Official topic areas from the CFA Institute outline, in outline order.
7.1 Fixed-income instruments, features, and issuanceBond features, types, and how bonds are issued.
- What it means
- This covers the features of fixed-income securities, issuer, maturity, par value, coupon rate and frequency, seniority, and embedded options (callable, putable, convertible), the main types of bonds (government and agency, corporate, municipal, securitized), and how bonds are issued and traded in primary and secondary markets.
- What to understand
- A bond is a loan with defined terms: the issuer pays periodic coupons and repays principal at maturity. Embedded options change the risk and value (a call benefits the issuer, a put the holder). Bond types differ in credit risk and features. Knowing the features and types, and the effect of embedded options, is foundational to the topic.
- How it shows up
- A bond-feature or type situation is described, and you must identify the feature, option effect or bond type.
- Common confusion
- Confusing callable (benefits issuer) with putable (benefits holder) bonds, or the bond types.
7.2 Bond pricing, yields, and the term structureValuing bonds, the price-yield relationship, and yields.
- What it means
- This covers pricing a bond as the present value of its future cash flows discounted at the required yield, the inverse relationship between price and yield, and the yield measures: current yield, yield to maturity, yield to call, spot and forward rates, and the yield curve (term structure of interest rates).
- What to understand
- A bond's price is the present value of its coupons and principal; when the required yield rises, the price falls, and vice versa (the inverse relationship). Yield to maturity is the single rate equating price to the cash flows' present value. Spot rates discount single future cash flows, and the yield curve shows yields across maturities. Knowing how to price bonds and the yield measures, and the inverse relationship, is heavily tested.
- How it shows up
- A bond-pricing or yield situation is described, and you must price the bond or apply the yield measure or the inverse relationship.
- Common confusion
- Reversing the inverse price-yield relationship, or confusing the yield measures (current yield versus yield to maturity).
7.3 Interest rate risk: duration and convexityMeasuring a bond's price sensitivity to yields.
- What it means
- This covers interest rate risk: duration, which measures the approximate percentage change in a bond's price for a change in yield (and reflects the weighted average time to cash flows), and convexity, which captures the curvature of the price-yield relationship that duration alone misses.
- What to understand
- Duration estimates how much a bond's price moves for a given yield change: higher duration means more sensitivity, and longer-maturity, lower-coupon bonds have higher duration. Convexity refines the estimate because the true price-yield relationship is curved, not linear. Knowing how to use duration and convexity to estimate price changes is central and heavily tested.
- How it shows up
- A rate-change situation is described, and you must apply duration and convexity to estimate the price change.
- Common confusion
- Confusing the drivers of duration (maturity and coupon), or ignoring convexity for large yield changes.
7.4 Credit analysis and securitized productsAssessing default risk and understanding structured products.
- What it means
- This covers credit analysis, assessing the risk that an issuer defaults, through credit ratings, credit spreads, and factors like the issuer's capacity and the bond's covenants and seniority, and securitized products, asset-backed securities (ABS) and mortgage-backed securities (MBS) created by pooling and tranching loans.
- What to understand
- Credit risk is the risk of non-payment, reflected in ratings (investment grade versus high yield) and the credit spread over a risk-free rate, which widens as perceived risk rises. Securitization pools loans and issues tranches with different risk and priority. Knowing how to assess credit risk and understand securitized structures is tested.
- How it shows up
- A credit or securitization situation is described, and you must assess the risk or identify the structure.
- Common confusion
- Confusing credit risk (default) with interest-rate risk (yield changes), or misunderstanding tranching and seniority.
High-yield concepts
The terms, rules and formulas this domain turns into questions most often.
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Bond features
Issuer, maturity, coupon, options.
- Remember
- Define the cash flows and risk.
- Tested as
- Instrument questions.
- Trap
- Overlooking embedded options.
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Callable vs. putable
Benefits issuer versus holder.
- Remember
- Call lets the issuer redeem early.
- Tested as
- Instrument questions.
- Trap
- Confusing the two.
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Bond pricing
PV of future cash flows.
- Remember
- Discount at the required yield.
- Tested as
- Pricing questions.
- Trap
- Mispricing the bond.
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Inverse price-yield
Price and yield move oppositely.
- Remember
- Yields up, prices down.
- Tested as
- Pricing questions.
- Trap
- Reversing it.
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Yield to maturity
Single rate equating price to cash flows.
- Remember
- The bond's internal rate of return.
- Tested as
- Yield questions.
- Trap
- Confusing with current yield.
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Spot and forward rates
Rates for single future cash flows.
- Remember
- Build the yield curve.
- Tested as
- Term-structure questions.
- Trap
- Confusing the rates.
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Duration
Price sensitivity to yield changes.
- Remember
- Higher for long, low-coupon bonds.
- Tested as
- Risk questions.
- Trap
- Ignoring the drivers.
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Convexity
Curvature of the price-yield relationship.
- Remember
- Refines the duration estimate.
- Tested as
- Risk questions.
- Trap
- Ignoring it for large moves.
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Credit risk
Risk of issuer default.
- Remember
- Reflected in ratings and spreads.
- Tested as
- Credit questions.
- Trap
- Confusing with interest-rate risk.
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Credit spread
Yield over the risk-free rate.
- Remember
- Widens as risk rises.
- Tested as
- Credit questions.
- Trap
- Ignoring spread changes.
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Securitization
Pooling and tranching loans.
- Remember
- Creates ABS and MBS.
- Tested as
- Structured questions.
- Trap
- Misunderstanding tranches.
Side by side
Concepts candidates mix up, compared on the point that decides the answer.
Callable vs. putable bonds
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Callable | Issuer can redeem early | Benefits the issuer | Confusing with putable |
| Putable | Holder can sell back early | Benefits the holder | Confusing with callable |
Current yield vs. yield to maturity
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Current yield | Coupon divided by price | Ignores capital gain/loss and time | Confusing with YTM |
| Yield to maturity | Total return if held to maturity | Equates price to cash flows | Confusing with current yield |
Interest-rate vs. credit risk
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Interest-rate risk | Price moves with yields | Measured by duration | Confusing with credit |
| Credit risk | Risk of default | Measured by ratings and spreads | Confusing with interest-rate |
Exam traps
Each trap is an answer that looks right. Learn the clue that should change your mind.
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Rates up, prices up
- What candidates pick
- Expect a bond's price to rise when market yields rise.
- Why it looks right
- Higher yields sound good.
- Why it's wrong
- Bond prices move inversely to yields: when required yields rise, existing bond prices fall.
Clue to watch for Yields rise and the question asks about price.
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Current yield is total return
- What candidates pick
- Use the current yield as the bond's total return to maturity.
- Why it looks right
- It is a yield.
- Why it's wrong
- Current yield is just coupon over price; yield to maturity captures the total return including capital gain or loss and the time value.
Clue to watch for The question needs the return if held to maturity.
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Short bonds are most rate-sensitive
- What candidates pick
- Assume short-maturity, high-coupon bonds have the highest interest-rate risk.
- Why it looks right
- Any bond has risk.
- Why it's wrong
- Longer-maturity, lower-coupon bonds have higher duration and are more sensitive to yield changes.
Clue to watch for The bond is long-maturity and low-coupon.
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Ignore convexity
- What candidates pick
- Estimate a large price change using duration alone.
- Why it looks right
- Duration gives a price change.
- Why it's wrong
- For large yield changes, convexity matters because the price-yield relationship is curved; duration alone under- or over-estimates.
Clue to watch for The yield change is large.
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Credit risk is rate risk
- What candidates pick
- Attribute a bond's price fall to credit risk when yields rose generally.
- Why it looks right
- Both move prices.
- Why it's wrong
- A general rise in yields is interest-rate risk; credit risk concerns the specific issuer's chance of default and its spread.
Clue to watch for The move is due to rates versus issuer-specific default risk.
Answer framework
For any Fixed Income question, use these steps to find the answer the exam expects.
- Identify the bond's features and type, including any embedded options (callable benefits the issuer, putable the holder).
- Price the bond as the present value of its cash flows, applying the inverse price-yield relationship and the right yield measure.
- Assess interest-rate risk with duration (higher for long, low-coupon bonds) and refine with convexity for large yield changes.
- Assess credit risk through ratings and the credit spread, distinguishing it from interest-rate risk.
- Identify securitized structures (ABS, MBS) and their tranching, choosing the analytically correct answer. Where two options seem to fit, choose the one that most precisely applies the CFA concept, formula or standard the question is testing.
Practice question
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Study strategy
Give this heavy topic strong study time, since at 11-14% it is one of the largest and, with derivatives, where many candidates struggle. Start with bond features and types, including embedded options (callable versus putable). Then master pricing: value a bond as the present value of its cash flows, drill the inverse price-yield relationship until automatic, and learn the yield measures, keeping current yield distinct from yield to maturity.
Master interest-rate risk, the heart of the topic: duration (and its drivers, maturity and coupon) to estimate price changes, and convexity to refine the estimate for large moves. Then learn credit analysis (ratings, spreads, distinguishing credit from interest-rate risk) and the basics of securitized products.
Because fixed income is calculation-heavy and uses the time value of money, practice pricing and duration problems with the financial calculator. Because CFA Level 1 mixes concepts with calculations, practice the formulas by hand with a financial calculator, drill large question banks by topic, and take full mock exams to build speed and stamina across all ten topics. Afterwards, move to Derivatives.
FAQ
How much of CFA Level 1 is Fixed Income?
Fixed Income is 11-14% of the exam, one of the three heaviest topics. Along with derivatives, it is where many candidates struggle, so it deserves strong effort.
What is the inverse price-yield relationship?
Bond prices and yields move in opposite directions: when the required yield rises, the price of an existing bond falls, and when the yield falls, the price rises. This is because a bond's price is the present value of fixed cash flows discounted at the yield.
What is the difference between current yield and yield to maturity?
Current yield is the annual coupon divided by the current price, ignoring capital gains or losses and the time value of money. Yield to maturity is the single rate that equates the bond's price to the present value of all its cash flows, capturing the total return if held to maturity.
What is duration?
Duration measures a bond's price sensitivity to changes in yield, approximating the percentage price change for a given change in yield. It is higher for longer-maturity and lower-coupon bonds, which are more sensitive to interest rate changes.
Why does convexity matter?
Because the true relationship between a bond's price and its yield is curved, not linear, duration alone becomes inaccurate for large yield changes. Convexity captures this curvature and refines the estimate of the price change.
What is the difference between a callable and a putable bond?
A callable bond gives the issuer the right to redeem it early, which benefits the issuer (usually when rates fall). A putable bond gives the holder the right to sell it back early, which benefits the holder (usually when rates rise). The embedded option affects value and risk.
How does Fixed Income connect to the rest of the exam?
It uses the time value of money from quantitative methods, depends on interest rates and monetary policy from economics, and its credit analysis uses the financial statements from financial statement analysis, while bonds are a key asset class in portfolio management.
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Test your Domain 7 knowledge
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