Chartered Financial Analyst (CFA) Practice Exam Level 2

Which type of bond allows for a rate that is paid in arrears?

1. Callable Bond

2. Putable Bond

3. Fixed Rate Bond

4. Floating Rate Bond

The correct answer is: Floating Rate Bond

A floating rate bond allows for a rate that is paid in arrears. This type of bond has a variable interest rate that typically resets periodically based on a benchmark interest rate, such as LIBOR or SOFR, plus a fixed spread. The payments on this bond occur after the interest rate has been established based on the most recent reset period, which is why it is said to be paid in arrears. In contrast, callable bonds give the issuer the right to redeem the bond before its maturity at specific times and under certain conditions, which does not necessarily pertain to the payment of interest. Putable bonds provide the investor with the right to sell the bond back to the issuer at predetermined times, which is also unrelated to the interest payment structure. Fixed rate bonds have a set interest rate that does not change over the life of the bond, and the interest is typically paid at specified intervals, rather than based on a reset mechanism. The key feature of floating rate bonds is their connection to current market interest rates, which influences how and when interest is paid.