Fixed Income carries an 11-14% weight at CFA Level 1, putting it alongside FRA and Equity as one of the three highest-weighted sections. Despite this, it’s often the section candidates least enjoy studying. Bonds lack the excitement of stock picking, and terms like “modified duration” and “convexity” can feel abstract.
Here’s the truth though: Fixed Income is one of the most scoreable sections on the exam once you understand the core mechanics. The calculations are predictable, the concepts follow logical patterns, and the question types repeat across exams. Candidates who invest the right study time in Fixed Income consistently outperform those who don’t.
What Fixed Income Covers at Level 1
Bond Features and the Market
Before diving into pricing, you need to understand the basics:
- Types of bonds (government, corporate, municipal, sovereign)
- Bond features (coupon rate, maturity, par value, call/put provisions)
- Bond indentures and covenants
- Primary and secondary bond markets
- Bond market participants
This is foundational material that’s mostly qualitative. Read it once carefully and you’ll be fine.
Bond Pricing and Valuation
This is where Quant’s time value of money becomes directly applicable. Bond pricing is simply the present value of future cash flows — coupon payments plus the return of par value at maturity.
Key calculations:
- Pricing a bond given a discount rate
- Pricing between coupon dates (accrued interest and clean vs. dirty price)
- Relationship between coupon rate, yield, and price (premium, par, discount)
Critical understanding: When market yields rise, bond prices fall. When yields fall, prices rise. This inverse relationship — driven heavily by monetary policy and macroeconomic forces — is the single most important concept in fixed income. If you understand why it works (higher discount rates reduce present values), everything else in the section makes sense.
Yield Measures
Different yield measures serve different purposes:
- Current yield: Annual coupon / price — simple but incomplete
- Yield to maturity (YTM): The discount rate that equates price to the PV of cash flows — the most commonly used measure
- Yield to call: Same concept but assuming the bond is called at the earliest call date
- Yield to worst: The lowest of YTM, YTC, and any other applicable yield measure
Exam tip: YTM assumes you can reinvest coupons at the YTM rate. This reinvestment assumption is a limitation the exam frequently tests.
The Term Structure of Interest Rates
This section covers yield curves — perhaps the most practically important topic in all of fixed income.
Key areas:
- Spot rates vs. forward rates
- Constructing a yield curve
- Theories explaining yield curve shapes (expectations, liquidity preference, segmented markets)
- Calculating forward rates from spot rates
What you must know: How to bootstrap spot rates and calculate implied forward rates. These calculations appear regularly on the exam and are straightforward once you’ve practiced them.
Duration and Convexity
Duration measures a bond’s sensitivity to interest rate changes. It’s the most important risk measure in fixed income.
You need to understand:
- Macaulay duration: Weighted average time to receive cash flows
- Modified duration: Percentage price change for a 1% change in yield
- Effective duration: Used for bonds with embedded options
- Dollar duration: Absolute price change for a 1% change in yield
And then convexity:
- Why duration alone is insufficient for large yield changes
- How convexity improves the price change estimate
- Why positive convexity is desirable for bondholders
The key formula: Approximate % price change = (-Modified Duration x Change in Yield) + (0.5 x Convexity x Change in Yield squared)
This formula gets tested in various forms. Know it cold.
Credit Analysis
Credit analysis covers the risk that a bond issuer fails to make promised payments:
- Credit ratings (investment grade vs. high yield)
- Credit spreads and what drives them
- Recovery rates and loss given default
- Credit migration risk
Why Fixed Income Deserves Your Attention
Predictable question types: Fixed Income questions tend to follow identifiable patterns. Bond pricing, duration calculations, yield curve questions, and credit spread interpretations repeat across exams. This predictability means that targeted practice yields high returns.
Strong connection to Quant: If you’ve mastered time value of money in Quant, bond pricing is a direct application. You’re essentially doing PV calculations with specific real-world context.
Level 2 and 3 foundation: Fixed Income becomes significantly more complex at higher levels, covering structured products, credit derivatives, and yield curve strategies. The fundamentals you build at Level 1 are essential.
Study Strategy for Fixed Income
Start with bond pricing and don’t leave until it’s automatic
Bond pricing is the foundation. If you can price a bond quickly and accurately, you’ll handle 30-40% of Fixed Income questions without difficulty. Practice pricing bonds with annual coupons, semi-annual coupons, and zero-coupon bonds until it’s mechanical.
Build intuition for duration before memorizing formulas
Before you calculate modified duration, make sure you can answer these questions intuitively:
- Does a longer maturity increase or decrease duration? (Increase)
- Does a higher coupon increase or decrease duration? (Decrease)
- Does a higher yield increase or decrease duration? (Decrease)
- Is the duration of a zero-coupon bond higher or lower than a coupon bond of the same maturity? (Higher — it equals the maturity)
These intuitive relationships are tested more frequently than the actual duration calculation.
Practice forward rate calculations repeatedly
Calculating forward rates from spot rates is a mechanical skill that the exam tests regularly. The formula is logical but requires practice to execute quickly:
(1 + S2)^2 = (1 + S1)^1 x (1 + f(1,1))^1
Where S2 is the 2-year spot rate, S1 is the 1-year spot rate, and f(1,1) is the 1-year rate one year from now.
Do 15-20 of these problems and the pattern becomes automatic.
Understand yield curve theories conceptually
The exam tests whether you can explain why the yield curve has a particular shape. Know the three theories:
- Pure expectations: Forward rates are unbiased predictors of future spot rates
- Liquidity preference: Investors demand a premium for longer maturities, so yield curves have an upward bias
- Segmented markets: Different maturities are distinct markets with supply/demand dynamics
Common Mistakes in Fixed Income
Mistake 1: Forgetting to adjust for semi-annual coupons. Most bonds pay coupons semi-annually. This means you divide the annual coupon by 2, divide the yield by 2, and multiply the number of periods by 2. Forgetting this adjustment is the most common calculation error.
Mistake 2: Confusing Macaulay and modified duration. Macaulay duration is measured in years. Modified duration is the percentage price sensitivity. They’re related (Modified = Macaulay / (1 + yield/n)) but serve different purposes.
Mistake 3: Ignoring the convexity adjustment. For small yield changes, duration alone is a good approximation. For large changes, you need the convexity correction. The exam will sometimes give you both duration and convexity and expect you to use both.
Mistake 4: Misunderstanding the relationship between credit spreads and yields. When credit spreads widen, bond prices fall. When they narrow, prices rise. This seems obvious, but under exam pressure, candidates sometimes confuse the direction.
Mistake 5: Using the wrong duration measure for callable bonds. Modified duration assumes cash flows don’t change when yields change. For callable bonds, cash flows can change (the issuer might call the bond), so you must use effective duration instead.
Practical Exam Tips
Tip 1: When a question asks about the impact of a yield change on bond price, always check whether duration and convexity are both provided. Use both if available.
Tip 2: For questions about two bonds, the one with higher duration is more sensitive to interest rate changes. This comparison is frequently tested.
Tip 3: Forward rate questions follow a predictable calculation pattern. Once you see the structure, execute mechanically and move on.
Tip 4: Credit analysis questions tend to be qualitative. Know the factors that affect credit ratings and credit spreads, and you’ll handle these efficiently.
Time Allocation
Plan for 40-50 hours on Fixed Income:
- Bond features and markets: 5-6 hours
- Bond pricing and yields: 10-12 hours
- Term structure and forward rates: 8-10 hours
- Duration and convexity: 10-12 hours
- Credit analysis: 5-6 hours
- Practice problems: 8-10 hours
Final Thoughts
Fixed Income is a section that rewards structured, methodical study. The concepts build on each other logically — pricing leads to yields, yields lead to term structure, term structure leads to duration. Follow this progression and the subject unfolds naturally.
Don’t let the reputation for being dry discourage you. Some of the most reliable marks on the CFA Level 1 exam come from Fixed Income, precisely because the question types are predictable and the calculations are systematic. If you’re pursuing a career in the bond markets, our asset management guide explores how the CFA charter supports that path.
If you want help building a Fixed Income study plan or need clarification on concepts like duration and convexity, reach out for a free mentorship session. Fixed Income is the subject where good coaching makes the biggest difference.