9. Fixed Income Port Management / Evaluation of Port Performance

Question 1

If the modified duration of a bond portfolio is less than the implied sensitivity (modified duration) of the liabilities it is funding…

Answer 1

• It is subject to reinvestment risk.
• Less cash (coupons and maturity redemptions) is coming into the portfolio than the liabilities it is funding. These need to be reinvested, and are therefore exposed to reinvestment risk

Question 2

Describe how you could increase the convexity of the portfolio while keeping the modified duration at the same level.

Answer 2

-Increase convexity by spreading out the cash flows (using a bond ladder strategy) and or/seek higher coupon bonds so cash flows will occur both earlier and later than the duration time frame in the portfolio

Question 3

If Treasury yields and corporate credit spreads are expected to decline, how would you restructure a bond portfolio to take advantage of this view?

Answer 3

• Extend durations to capture more price appreciation as yields decline: this can be done by purchasing longer maturity bonds and bonds with lower coupon rates
• Purchase corporate bonds since if their yield follow Treasury and decline, they will benefit from price appreciation

Question 4

If Duration > Investment horizon…

Answer 4

…the investor faces Net Price Risk

Question 5

If Duration

Answer 5

…the investor faces Net Reinvestment Risk

Question 6

If Duration = Investment horizon

Answer 6

…the investor is Immunized

Question 7

What is required of a portfolio manager (3)?

Answer 7

1. Follow the client’s policy statement
2. Earn above-average returns for a given risk class
3. Diversify the portfolio to eliminate unsystematic risk

Question 8

What are four possible explanations of superior performance for a portfolio manager?

Answer 8

1. Insightful ASSET ALLOCATION strategy that over-weighted an asset class that earn high returns
2. Investing in undervalued sectors (SECTOR ROTATION)
3. Selecting individual securities that earned above average returns (SECURITY SELECTION)
4. MARKET TIMING

Question 9

Sharpe ratio

Answer 9

• Based on the CML

- Shows the risk premium earned over the risk free rate per unit of TOTAL RISK

Question 10

Treynor ratio

Answer 10

• Based on the SML (CAPM)

- Shows the risk premium earned over the risk free rate per unit of SYSTEMATIC RISK

Question 11

Jensen’s Alpha

Answer 11

• Based on SML
• Shows the contribution (excess return) of portfolio manager beyond return attributable to systematic risk in the portfolio

Question 12

RAP/M2

Answer 12

• Based on CML

- The resulting value larger than the market return would indicate superior performance

Question 13

Information ratio

Answer 13

-Measures the average return in excess that of a benchmark portfolio divided by the standard deviation of this excess return