Free CISI Intro Practice Questions: Bonds

Use this focused CISI Intro page as a short practice test for Bonds. The items are original Finance Prep sample exam questions built for scenario-based practice, not trivia, puzzle questions, official CISI questions, copied live-exam content, or exam dumps.

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Sample questions

These are original Finance Prep practice questions aligned to this topic area. They are not official CISI questions, copied live-exam content, or exam dumps. Use them to preview question style and explanation depth before continuing with topic drills, mixed sets, and timed mock exams in Finance Prep.

Question 1

Topic: Bonds

An investor is comparing two corporate bonds. A credit rating agency scale ranks AA above BBB. For this comparison, flat yield is calculated as annual coupon income divided by the current clean price, multiplied by 100.

Which conclusion is most appropriate?

• A. Bond B has a 5.0% flat yield; its AA rating makes further issuer analysis unnecessary.
• B. Bond B has a 4.0% flat yield; its higher rating points to higher credit risk than Bond A.
• C. Bond A has a 5.0% flat yield; its lower rating points to higher credit risk, but this should be only one input.
• D. Bond A has a 4.8% flat yield; its BBB rating precisely measures the probability of default.

Best answer: C

What this tests: Bonds

Explanation: Flat yield compares annual coupon income with the current market price. Bond A’s flat yield is \(£4.80 / £96 \times 100 = 5.0\%\), while Bond B’s is \(£4.80 / £120 \times 100 = 4.0\%\). A lower credit rating usually indicates greater credit risk as assessed by the rating agency, so Bond A’s higher yield may partly compensate investors for that risk. However, ratings are opinions, not guarantees or precise default probabilities. They should be considered alongside other factors such as the issuer’s financial strength, sector conditions, bond terms, and market pricing.

• Using 4.8% for Bond A confuses the coupon rate with the flat yield and overstates what a rating can measure.
• Calculating Bond B at 5.0% uses the wrong price, and an AA rating does not remove the need for issuer analysis.
• Bond B’s 4.0% flat yield is lower than Bond A’s, and AA indicates lower agency-assessed credit risk than BBB on the scale provided.

Bond A’s flat yield is £4.80 divided by £96, and its BBB rating is lower than AA, so the rating is useful but not conclusive evidence of credit risk.

Question 2

Topic: Bonds

A portfolio manager is comparing two sterling fixed-rate corporate bonds. Both have five years to maturity, similar coupons, and normal daily trading volumes. Bond X is issued by a financially strong company with an investment-grade rating. Bond Y is issued by a company that has recently been downgraded after cash-flow problems, and its yield is higher because investors are concerned it may struggle to pay coupons and repay capital at maturity.

Which risk is the main differentiator between the two bonds?

• A. Credit risk
• B. Liquidity risk
• C. Interest-rate risk
• D. Currency risk

Best answer: A

What this tests: Bonds

Explanation: Credit risk is the risk that a bond issuer will fail to meet its payment obligations, such as paying coupons or repaying the bond at maturity. In this case, the two bonds have the same currency, similar coupons, the same remaining term, and normal trading volumes, so the main difference is not market-rate sensitivity or ease of sale. The higher yield on Bond Y reflects compensation demanded by investors for taking on a weaker issuer with a greater chance of default or downgrade-related loss.

• Interest-rate risk would be more relevant if the key difference were maturity, duration, coupon structure, or sensitivity to changes in market interest rates.
• Liquidity risk would be more relevant if one bond were hard to sell quickly or could only be sold at a large price discount.
• Currency risk is not the main issue because both bonds are sterling-denominated.

The decisive concern is the weaker issuer’s ability to make coupon payments and repay principal.

Question 3

Topic: Bonds

A bond is issued below its face value, pays no periodic interest, and the investor’s return comes mainly from repayment at par on maturity. Which term best matches this bond?

• A. Perpetual bond
• B. Zero-coupon bond
• C. Fixed-rate bond
• D. Floating-rate note

Best answer: B

What this tests: Bonds

Explanation: A zero-coupon bond does not pay regular interest during its life. Instead, it is usually issued or traded at a discount to its face value, and the investor receives the full par amount when the bond matures. The return therefore comes from the uplift between the lower purchase price and the redemption value, rather than from coupon income.

By contrast, a floating-rate note does pay interest, but the coupon changes with a reference rate. A fixed-rate bond pays a set coupon, and a perpetual bond may pay income but typically has no stated redemption date. The key clue here is no periodic interest plus repayment at par on maturity.

• Floating income: A floating-rate note pays coupons that vary over time, so it does not match a bond with no periodic interest.
• No maturity date: A perpetual bond is defined by having no fixed redemption date, which conflicts with repayment at maturity.
• Regular coupon: A fixed-rate bond pays a constant stated coupon, so the investor’s return is not mainly from discount to redemption.

A zero-coupon bond pays no regular coupon and is typically bought at a discount, with the gain realised at redemption.

Question 4

Topic: Bonds

A trainee is reviewing the following bond term sheet excerpt for a client:

Which bond term best describes the income and repayment pattern shown?

• A. Convertible bond
• B. Floating-rate note
• C. Index-linked bond
• D. Zero-coupon bond

Best answer: D

What this tests: Bonds

Explanation: A zero-coupon bond does not pay regular coupon interest. Instead, it is normally issued below its redemption value and the investor’s return comes from receiving the higher amount at maturity. In the excerpt, the bond is issued at £93, pays a 0% annual coupon, and redeems at £100. That pattern supports the zero-coupon description. The exhibit does not show a variable coupon, inflation adjustment, or a right to exchange the bond for shares, so those terms are not supported by the stated features.

• Floating-rate note would require interest that changes by reference to a benchmark or formula, but the coupon shown is 0%.
• Index-linked bond would need payments or redemption linked to an inflation index, which is not stated.
• Convertible bond would include a conversion right into shares, which is not shown in the terms.

The bond pays no periodic interest and gives the investor a return through the difference between the issue price and redemption value.

Question 5

Topic: Bonds

A bond denominated in one currency but issued outside the jurisdiction of that currency, such as a US dollar bond issued in London, is best described as which type of bond?

• A. Convertible bond
• B. Foreign bond
• C. Eurobond
• D. Floating-rate note

Best answer: C

What this tests: Bonds

Explanation: The core concept is the distinction between issuance location and other bond features. A eurobond is a bond issued outside the domestic market of the currency in which it is denominated. So a US dollar bond issued in London is a eurobond. Despite the name, a eurobond does not have to be denominated in euros.

A foreign bond is different: it is typically issued by a foreign borrower into a domestic market, usually in that market’s currency, such as a non-UK company issuing sterling bonds in the UK domestic market. By contrast, a convertible bond and a floating-rate note describe structural or income features, not the market of issue. The key takeaway is that eurobond refers to where the bond is issued relative to its currency.

• Foreign bond: This is the closest alternative, but it refers to an overseas issuer borrowing in a domestic market, not a bond issued outside the currency’s home market.
• Convertible bond: This describes a bond that may be converted into shares, so it is about conversion rights rather than issuance location.
• Floating-rate note: This describes a variable coupon structure linked to a reference rate, not the jurisdiction of issue.

A eurobond is issued outside the domestic market or jurisdiction of the currency in which it is denominated.

Question 6

Topic: Bonds

A trainee is reviewing this bond term sheet excerpt for a UK public-sector borrowing discussion. Which conclusion is best supported?

Issuer: HM Treasury, United Kingdom
Security name: 4.00% Treasury Gilt 2031
Coupon: Fixed at 4.00% a year
Redemption: 100 at maturity
Purpose: General government financing

• A. It guarantees that the investor cannot suffer a market value fall before maturity.
• B. It is a corporate bond because the coupon is fixed and paid annually.
• C. It is a conventional gilt: a UK government bond with fixed coupons and scheduled par repayment, generally viewed as high credit quality.
• D. It is an index-linked gilt because the redemption amount is stated as 100 at maturity.

Best answer: C

What this tests: Bonds

Explanation: Gilts are bonds issued by the UK government to finance public-sector borrowing. A conventional gilt pays a fixed coupon and has a stated redemption value, usually expressed as 100, payable at maturity if the issuer meets its obligations. UK government bonds are generally perceived as high credit quality because they are backed by the sovereign issuer, although they are not free from all risk. Their market price can still rise or fall before maturity as interest rates, inflation expectations, and market conditions change. An index-linked gilt would have coupon and redemption amounts linked to an inflation index, which is not shown here.

• Treating the bond as index-linked misreads the fixed coupon and stated nominal redemption.
• Treating it as a corporate bond ignores the issuer, HM Treasury, United Kingdom.
• Assuming no possible market value fall overstates what a gilt provides; high perceived credit quality is not the same as price certainty before maturity.

The UK government issuer, fixed coupon, and redemption at 100 identify a conventional gilt used for government borrowing.

Question 7

Topic: Bonds

A UK investment firm is reviewing two sterling corporate bonds before adding one to an income shortlist. Bond A is rated A and yields 4.5%. Bond B is rated BB and yields 7.5%. A trainee suggests choosing Bond B first because it has the higher yield. What is the best next step in the review process?

• A. Refer the yield difference to HMRC before deciding whether either bond is suitable.
• B. Treat Bond B as the lower-risk bond because investors are being offered a higher yield.
• C. Classify Bond B as non-investment-grade and assess whether its higher yield compensates for its higher default risk.
• D. Ignore the ratings and add the bond with the highest yield to the shortlist.

Best answer: C

What this tests: Bonds

Explanation: Investment-grade bonds are issued by borrowers judged to have relatively stronger credit quality and lower default risk. Non-investment-grade bonds, often called high-yield bonds, have weaker credit ratings and a higher risk that the issuer may fail to meet interest or repayment obligations. Because investors take on more credit risk, they normally require a higher yield as compensation. In the scenario, A is investment grade, while BB is below investment grade. The correct process is not to select the highest yield automatically, but to recognise what the rating implies and consider whether the extra return is adequate for the additional risk.

• A higher yield does not itself mean lower risk; it often signals that investors require compensation for greater credit risk.
• Ranking bonds purely by yield skips the credit-quality assessment that is central to bond selection.
• HMRC is not the process owner for assessing bond credit quality or suitability for an investment shortlist.

A BB rating indicates lower credit quality than investment-grade bonds, so the higher yield should be viewed as compensation for greater default risk.

Question 8

Topic: Bonds

A UK investor is worried that inflation will erode the real value of bond income and the amount repaid at maturity. She wants a government bond where both the coupon and redemption payment move broadly in line with inflation. Which bond term best matches this feature?

• A. Perpetual bond
• B. Floating-rate note
• C. Index-linked gilt
• D. Zero-coupon bond

Best answer: C

What this tests: Bonds

Explanation: An index-linked gilt is a UK government bond whose payments are linked to inflation. That means the coupon amount and the amount repaid at maturity are adjusted so that, if inflation rises, the investor’s cash flows also rise broadly with it. This directly addresses inflation risk, which is the loss of real purchasing power from fixed nominal payments.

A floating-rate note changes its coupon with interest rates, not inflation, and its repayment amount is normally fixed. A zero-coupon bond pays no regular income, so it does not meet the income feature in the stem. A perpetual bond may pay income indefinitely, but it has no maturity date, so there is no redemption payment to adjust.

The key clue is the combination of inflation-linked income and inflation-linked repayment at maturity.

• Floating coupon confusion: A floating-rate note resets interest with market rates, but its capital repayment is usually not inflation-linked.
• No income: A zero-coupon bond is issued at a discount and repays at maturity, so it does not provide the regular coupon income described.
• No maturity: A perpetual bond can pay ongoing coupons, but it generally has no set redemption date, so it does not match a maturity repayment feature.

An index-linked gilt adjusts interest and redemption amounts with inflation, helping preserve real value.

Question 9

Topic: Bonds

A UK investor is comparing two five-year corporate bonds from the same issuer, credit quality and redemption value. One is zero-coupon and one pays a fixed annual coupon. She wants some income during the term and may need to sell before maturity. Which choice best applies the suitability principle?

• A. Choose the zero-coupon bond because it usually moves less when market yields change.
• B. Choose the zero-coupon bond because its discounted purchase price creates regular yearly income.
• C. Choose the coupon-paying bond because coupon receipts remove the issuer’s credit risk.
• D. Choose the coupon-paying bond because it provides interim income and is usually less price-sensitive before maturity.

Best answer: D

What this tests: Bonds

Explanation: The key principle is matching the bond’s cash-flow pattern and price risk to the investor’s needs. A zero-coupon bond pays no coupons, so the investor receives no income while holding it; instead, it is typically bought below its redemption value and the return builds up until maturity. That can suit a known future lump-sum target, but it does not suit this investor’s wish for ongoing income.

If two bonds have the same issuer and maturity, the zero-coupon bond will usually be more sensitive to changes in market yields because all of its cash flow arrives at the end. A coupon-paying bond distributes part of the return earlier and is generally less volatile before maturity. So the better fit here is the coupon-paying bond, not the zero-coupon bond bought at a discount.

• The discounted price of a zero-coupon bond does not mean annual income is paid; the return is mainly realised at maturity.
• Zero-coupon bonds are typically more, not less, sensitive to yield changes than otherwise similar coupon-paying bonds.
• Receiving coupons does not remove the issuer’s credit risk; the issuer could still miss future payments or fail to repay principal.

It matches her need for interim income and, if sold early, is usually less sensitive to yield changes than an otherwise similar zero-coupon bond.

Question 10

Topic: Bonds

A UK Treasury gilt is quoted with the following details:

Ignoring tax and accrued interest, which statement best describes the income feature shown by these figures?

• A. The gilt pays £3.06 a year per £100 nominal, giving a flat yield of 3.5% at the quoted price.
• B. The gilt pays £3.50 a year per £100 nominal, giving a flat yield of 3.5% at the quoted price.
• C. The gilt pays £4.00 a year per £100 nominal, giving a flat yield of 4.0% at the quoted price.
• D. The gilt pays £3.50 a year per £100 nominal, giving a flat yield of 4.0% at the quoted price.

Best answer: D

What this tests: Bonds

Explanation: A conventional gilt pays a fixed coupon based on its nominal value, not on its current market price. Here, a 3.50% coupon on £100 nominal means annual interest of £3.50 per £100 nominal. The flat yield compares that annual interest with the price paid: £3.50 ÷ £87.50 = 0.04, or 4.0%. When a gilt trades below its nominal value, the flat yield is higher than the coupon rate because the investor is paying less than £100 for the same £3.50 annual coupon income.

• Applying 3.50% to the market price produces £3.06, but the coupon is calculated on nominal value.
• Treating 4.0% as the cash coupon confuses the yield percentage with the annual interest amount.
• Using 3.5% as the yield ignores that the gilt is priced below its £100 nominal value.

A 3.50% coupon on £100 nominal pays £3.50 a year, and £3.50 divided by the £87.50 price gives a 4.0% flat yield.

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