Fixed income is the study of debt securities such as bonds. A bond is basically a contract: the issuer borrows money, promises periodic interest payments, and repays principal at maturity if it does not default. The details can get complex, but the foundation is clear.
For CFA prep, fixed income is important because it combines time value of money, risk, cash flows, and market interest rates.
Bond Price and Yield Move Opposite
The most important fixed income relationship is this: when required yields rise, existing bond prices fall. When required yields fall, existing bond prices rise.
Why? A bond is a set of future cash flows. If investors now require a higher return, those same promised cash flows must be discounted at a higher rate. Higher discount rate means lower present value. Lower present value means lower bond price.
Coupon Rate vs Yield
The coupon rate is the interest rate stated on the bond. It determines the coupon payment. Yield is the return investors require or expect based on the bond price and cash flows.
A bond can have a coupon rate of 5 percent but trade at a yield above or below 5 percent depending on market rates, credit risk, and price. Do not treat coupon and yield as the same thing.
Par, Premium, and Discount
If a bond trades at its face value, it trades at par. If it trades above face value, it trades at a premium. If it trades below face value, it trades at a discount.
A bond with a coupon higher than the market yield often trades at a premium because its payments are attractive. A bond with a coupon lower than market yield often trades at a discount because investors need a lower price to earn the required return.
Duration in Plain English
Duration measures sensitivity to interest rate changes. Higher duration means the bond price is more sensitive to changes in yield. Long maturity bonds usually have higher duration than short maturity bonds. Lower coupon bonds usually have higher duration than higher coupon bonds, all else equal.
Duration is not just a formula. It is a risk measure. If rates rise, high-duration bonds tend to fall more. If rates fall, high-duration bonds tend to rise more.
Credit Risk
Credit risk is the risk that the issuer cannot make promised payments. Government bonds from strong issuers usually have lower credit risk. Corporate bonds vary widely. A company with stable cash flow and low debt is usually safer than a company with weak cash flow and heavy debt.
Investors demand extra yield for taking credit risk. This extra compensation is often called a spread.
Callable Bonds and Other Features
Some bonds give the issuer the right to call, or repay, the bond early. This can hurt investors when rates fall because the issuer may refinance at lower rates. The investor gets money back but may have to reinvest at a lower yield.
Features such as calls, puts, floating rates, and convertibility change risk and value. Always read the bond terms before analyzing the price.
Mini Example
Suppose a bond pays a fixed coupon of 4 percent. New bonds with similar risk now offer 6 percent. Investors will not pay full price for the old 4 percent bond because they can get better income elsewhere. The old bond price falls until its yield becomes competitive.
CFA Prep Connection
Fixed income uses Quantitative Methods because bond valuation is present value math. It uses Financial Statement Analysis because credit risk depends on issuer quality. It uses Portfolio Management because bonds can reduce or reshape portfolio risk.
If you understand cash flows, discount rates, duration, and credit risk, many fixed income questions become manageable.
Study Checklist
- Separate coupon rate from yield.
- Remember price and yield move opposite.
- Use timelines for bond cash flows.
- Learn what duration measures.
- Identify credit risk and spread risk.
- Read embedded features carefully.
Final Thought
Fixed income is not only about safe investments. Bonds have interest rate risk, credit risk, reinvestment risk, liquidity risk, and structural risk. The job of the analyst is to understand which risk is being taken and whether the yield is enough compensation.
Deeper Learning Notes
Fixed income starts with promised cash flows, but the risk is not fixed. Prices move when yields, credit quality, liquidity, and embedded features change. The important habit is to separate the concept from the product. A concept explains how money works. A product is only one possible way to apply that concept. This keeps the lesson useful even when apps, rates, rules, or offers change.
How This Helps CFA and Finance Learners
For CFA candidates, fixed income links time value of money, credit analysis, duration, portfolio risk, and monetary policy effects. Even if you are not preparing for an exam, the CFA-style way of thinking is useful: define the objective, identify constraints, measure risk, compare alternatives, and avoid decisions based only on emotion.
Worked Mini Scenario
If market yields rise after a bond is issued, the old bond price usually falls so its return becomes competitive with new bonds. After the first answer, ask a second question: what assumption could make this conclusion wrong? That habit is what turns a simple money tip into better financial judgment.
Decision Framework
- Write the goal in one sentence.
- List the cash flows involved.
- Identify the biggest risk.
- Compare at least two realistic options.
- Check taxes, fees, liquidity, and timing.
- Make the smallest useful action first, then review.
What to Track
- Yield, duration, maturity, credit spread, coupon rate, and embedded options.
- The decision date and the review date.
- Any fee, penalty, lockup, or tax cost.
- The worst reasonable outcome, not only the expected outcome.
- Whether the plan still fits your income, family needs, and risk comfort.
Common Trap
Do not assume every bond is safe just because it is called fixed income. Rules of thumb are helpful, but they are not personal advice. They simplify the first draft. Your final choice should consider your own income stability, debt level, dependents, time horizon, and local rules.
Practice Questions
- What problem is this concept trying to solve?
- Which number would change your decision the most?
- What is the cost of waiting one month?
- What is the risk of acting too quickly?
- How would you explain the decision to a beginner in two sentences?
Beginner Worksheet
Use this worksheet to turn the article into action. First, write your current situation in one line. Second, write the number that matters most: Yield, duration, maturity, credit spread, coupon rate, and embedded options.. Third, write the risk you are trying to reduce. Fourth, write one action that can be done this week without waiting for perfect information.
Now make the idea personal. If your income stopped, markets moved, a bill arrived, or an exam deadline got closer, what would change? A strong financial decision still makes sense when conditions are less comfortable. If the plan only works in the best case, it needs a margin of safety.
Finally, explain the lesson out loud. Use this sentence: "This topic matters because Fixed income starts with promised cash flows, but the risk is not fixed. Prices move when yields, credit quality, liquidity, and embedded features change." If that explanation sounds clear, you are ready to practice. If it sounds confusing, reread the worked scenario and simplify the idea again.
Next FinnQuiz Step
Draw a bond cash-flow timeline and practice explaining why price and yield move in opposite directions. Then take a short quiz or write your own three-question quiz. If you can explain the idea, solve a small example, and name one risk, you understand it better than most casual readers.