A client asks why her "safe" bond fund lost 12% last year. The bonds didn't default. Rates rose. That single concept -- duration -- separates candidates who pass from those who don't.
Cash equivalents are short-term, highly liquid instruments that mature within one year. They carry minimal credit risk and virtually no price risk. You use them for capital preservation and liquidity, not growth.
A demand deposit is a bank account you can withdraw from at any time without notice. Checking accounts are demand deposits. Savings accounts and CDs are time deposits -- they may impose penalties for early withdrawal.
The FDIC insures deposits at member banks up to $250,000 per depositor, per insured institution, per ownership category. That means a married couple with a joint account and two individual accounts at the same bank can be covered for more than $250,000 total. The $250,000 limit became permanent after the 2008 financial crisis. Before that, the limit was $100,000.
TRAP: The old FDIC limit of $100,000 appears as a wrong answer. The current limit is $250,000 -- permanently raised in 2010.
Common mistakes
- Confusing FDIC limits. The FDIC insures $250,000 per depositor, per institution, per ownership category. Candidates who pick $100,000 are remembering the pre-2008 limit. Candidates who pick $500,000 are confusing FDIC with Securities Investor Protection Corporation (SIPC) coverage limits. Trap: $100,000 and $500,000 both appear as wrong choices.
- Mixing up GO and revenue bonds. General obligation bonds are backed by taxing power. Revenue bonds are backed by project income only. The exam presents scenarios describing a toll bridge or airport and asks which type of bond it is.
- Using YTM instead of YTC for callable bonds at a premium. When a callable bond trades above par, the issuer will likely call it. YTC gives the relevant (lower) yield. Candidates who report YTM overstate the expected return. Trap: the YTM answer choice is always higher and looks more attractive.
Bottom line
- FDIC insures $250,000 per depositor, per institution, per ownership category (not the pre-2008 $100,000, nor SIPC's separate limits).
- Money market instruments mature in one year or less: T-bills, commercial paper, banker's acceptances, negotiable CDs, repos, and federal funds.
- GO bonds rely on full taxing power; revenue bonds rely on a specific project's income only, regardless of issuer.
- TIPS adjust the principal for inflation while the coupon rate stays fixed.
Exam shortcut
When you see "rates rise, which bond falls most?" -- pick the longest maturity, lowest coupon. Zero-coupon bonds always win that contest. For muni versus corporate comparisons, divide the muni yield by (1 minus the tax rate) to get the taxable-equivalent yield. If you catch yourself multiplying instead, stop -- dividing always produces a number larger than the muni yield, which is the whole point.
The full lesson (about 3,657 words, 24 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- B5
- B6
- B7
- B8
- B9
- B10
- B11
- B12
- B13
- B14
- B15
- B16
- B17
- B18
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