Chapter 11-13 Fixed-Income Flashcards
CFAI Fixed-Income Flashcards
Accounting defeasance
Also called in-substance defeasance, accounting defeasance is a way of extinguishing a debt obligation by setting aside sufficient high-quality securities to repay the liability.
Active management
A portfolio management approach that allows risk factor mismatches relative to a benchmark index causing potentially significant return differences between the active portfolio and the underlying benchmark.
Active return
Portfolio return minus benchmark return.
Active risk
The annualized standard deviation of active returns, also referred to as tracking error (also sometimes called tracking risk).
Barbell
A fixed-income investment strategy combining short- and long-term bond positions.
Bear flattening
A decrease in the yield spread between long- and short-term maturities across the yield curve, which is largely driven by a rise in short-term bond yields-to-maturity.
Bear steepening
An increase in the yield spread between long- and short-term maturities across the yield curve, which is largely driven by a rise in long-term bond yields-to-maturity.
Bull flattening
A decrease in the yield spread between long- and short-term maturities across the yield curve, which is largely driven by a decline in long-term bond yields-to-maturity.
Bull steepening
An increase in the yield spread between long- and short-term maturities across the yield curve, which is largely driven by a decline in short-term bond yields-to-maturity.
Bullet
A fixed-income investment strategy that focuses on the intermediate term (or “belly”) of the yield curve.
Butterfly spread
A measure of yield curve shape or curvature equal to double the intermediate yield-to-maturity less the sum of short- and long-term yields-to-maturity.
Butterfly strategy
A common yield curve shape strategy that combines a long or short bullet position with a barbell portfolio in the opposite direction to capitalize on expected yield curve shape changes.
Carry trade across currencies
A strategy seeking to benefit from a positive interest rate differential across currencies by combining a short position (or borrowing) in a low-yielding currency and a long position(or lending) in a high-yielding currency.
Cash flow matching
Immunization approach that attempts to ensure that all future liability payouts are matched precisely by cash flows from bonds or fixed-income derivatives.
Cell approach
Stratified sampling A sampling method that guarantees that subpopulations of interest are represented in the sample. Also called representative sampling or cell approach.
Contingent immunization
Hybrid approach that combines immunization with an active management approach when the asset portfolio’s value exceeds the present value of the liability portfolio.
Covered interest rate parity
The relationship among the spot exchange rate, the forward exchange rate, and the interest rate in two currencies that ensures that the return on a hedged (i.e., covered) foreign risk-free investment is the same as the return on a domestic risk-free investment. Also called interest rate parity.
Duration matching
Immunization approach based on the duration of assets and liabilities. Ideally, the liabilities being matched (the liability portfolio) and the portfolio of assets (the bond portfolio)should be affected similarly by a change in interest rates.
Duration times spread
Weighting of spread duration by credit spread in order to incorporate the empirical observation that spread changes for lower-rated bonds tend to be consistent on a percentage, rather than absolute, basis.
Duration Times Spread (DTS)
Weighting of spread duration by credit spread to incorporate the empirical observation that spread changes for lower-rated bonds tend to be consistent on a percentage rather than absolute basis.
Enhanced indexing approach
Maintains a close link to the benchmark but attempts to generate a modest amount of outperformance relative to the benchmark.
Enhanced indexing strategy
Method investors use to match an underlying market index in which the investor purchases fewer securities than the full set of index constituents but matches primary risk factors reflected in the index.
Evaluated pricing
Matrix pricing An approach for estimating the prices of thinly traded securities based on the prices of securities with similar attributions, such as similar credit rating, maturity, or economic sector. Also called evaluated pricing.
Full replication approach
When every issue in an index is represented in the portfolio, and each portfolio position has approximately the same weight in the fund as in the index.
Immunization
An asset/liability management approach that structures investments in bonds to match (offset) liabilities’ weighted-average duration; a type of dedication strategy.
Key rate duration
A method of measuring interest rate sensitivities of a fixed-income instrument or portfolio to shifts in key points along the yield curve.
Liability-based mandates
Mandates managed to match or cover expected liability payments (future cash outflows) with future projected cash inflows.
Matrix pricing
An approach for estimating the prices of thinly traded securities based on the prices of securities with similar attributions, such as similar credit rating, maturity, or economic sector. Also called evaluated pricing.
Matrix pricing (or evaluated pricing)
Methodology for pricing infrequently traded bonds using bonds from similar issuers and actively traded government benchmarks to establish a bond’s fair value.
Negative butterfly
An increase in the butterfly spread due to lower short- and long-term yields-to-maturity and a higher intermediate yield-to-maturity.
Options on bond futures contracts
Instruments that involve the right, but not the obligation, to enter into a bond futures contract at a pre-determined strike (bond price) on a future date in exchange for an up-front premium.
Passive investment
In the fixed-income context, it is investment that seeks to mimic the prevailing characteristics of the overall investments available in terms of credit quality, type of borrower, maturity, and duration rather than express a specific market view.
Positive butterfly
A decrease in the butterfly spread due to higher short- and long-term yields-to-maturity and a lower intermediate yield-to-maturity.
Present value of distribution of cash flows methodology
Method used to address a portfolio’s sensitivity to rate changes along the yield curve. This approach seeks to approximate and match the yield curve risk of an index over discrete time periods.
Pure indexing
Attempts to replicate a bond index as closely as possible, targeting zero active return and zero active risk.
Rebate rate
The portion of the collateral earnings rate that is repaid to the security borrower by the security lender.
Relative value
A concept that describes the selection of the most attractive individual securities to populate the portfolio with, using ranking and comparing.
Repo rate
The interest rate on a repurchase agreement.
Repurchase agreements
In repurchase agreements, or repos, a security owner agrees to sell a security for a specific cash amount while simultaneously agreeing to repurchase the security at a specified future date (typically one day later) and price.
Reverse repos
Repurchase agreements from the standpoint of the lender.
Scenario analysis
What-if analysis that involves changing multiple assumptions at the same time in order to evaluate the change in an investment’s value.
Smart beta
Involves the use of transparent, rules-based strategies as a basis for investment decisions.
Spread duration
The change in bond price for a given change in yield spread. Also referred to as OAS duration when the option-adjusted spread (OAS) is the yield measure used.
Stratified sampling
A sampling method that guarantees that subpopulations of interest are represented in the sample. Also called representative sampling or cell approach.
Structural risk
Risk that arises from portfolio design, particularly the choice of the portfolio allocations.
Surplus
The difference between the value of assets and the present value of liabilities. With respect to an insurance company, the net difference between the total assets and total liabilities(equivalent to policyholders’ surplus for a mutual insurance company and stockholders’ equity for a stock company).
Swaption
This instrument grants a party the right, but not the obligation, to enter into an interest rate swap at a pre-determined strike (fixed swap rate) on a future date in exchange for an upfront premium.
Total return payer
Party responsible for paying the reference obligation cash flows and return to the receiver but that is also compensated by the receiver for any depreciation in the index or default losses incurred by the portfolio.
Total return receiver
Receives both the cash flows from the underlying index and any appreciation in the index over the period in exchange for paying the MRR plus a predetermined spread.
Total return swap
A swap in which one party agrees to pay the total return on a security. Often used as a credit derivative, in which the underlying is a bond.
Tracking error
The standard deviation of the differences between a portfolio’s returns and its benchmark’s returns; a synonym of active risk. Also called tracking risk. If returns are normally distributed, the portfolio’s return should be within +/? 1 standard deviation of the index’s return in 68% of time periods.
Tracking risk
The standard deviation of the differences between a portfolio’s returns and its benchmark’s returns; a synonym of active risk. Also called tracking error.
Conditions for Single Liability Immunization
MacDur(a) = IH(l)
Initial PV of Porfolio CFs(MVa) >= PV of Liability
Portfolio Convexity is minimized
Conditions for Multiple Liability Immunization
MVa > PVl
DDa = DDl or BPVa = BPVl
Convexity A > Convexity L
-however after this is met lower convexity is better
