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CFA Level III > Fixed Income > Flashcards

Fixed Income Flashcards

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CFA flashcards
1
Q

Fixed Income Benefits

A
  1. diversification - low corr w/ eqty
  2. regular cash flow
  3. inflation hedge
    • inf linked protects coupon/ principal
    • floating coupon protects coupon
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2
Q

Immunization

A

assets invested to meet liabilities; to min variability in r, replicating 0 coupon bond; need duration and convexity of A/L

  1. cash-flow matching
  2. duration matching
  3. contingent immunization: actively manage surplus, immunization before surplus is neg
  4. horizon match: ST liab = CF match, LT liab = duration match
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3
Q

Total Return Mandates

A

target abs return to outpreform index; active return

  1. pure indexing: little flexibility (bond selection)
  2. enhanced indexing: some flexibility
  3. active management: more flexibility
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4
Q

Bond Liquidity

A
  1. little hist pricing data: use matrix pricing
  2. act managers pref more liquid bonds (lower YTM)
  3. bonds are heterogeneous
  4. OTC: need to find counterparty
  5. quality
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5
Q

Bond Return

A
  1. yield on income: annual coupon/ bond price
  2. rolldown return: (proj ending/ beg price) - 1
  3. manager pred Δ price: -D(Δr) + ½C(Δr2)
  4. credit losses
  5. currency g/l
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6
Q

Rolling Yield

A

yield income + rolldown return

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7
Q

Leverage

A

using borrowed funds to purchase assets

rlev = ri + [( Vborrowed/ Veqty )*( ri- rb )]

risk: Δ in value collateral and ri - rb

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8
Q

Ways to Achieve Leverage

A
  1. repo
  2. futures
  3. swaps
  4. structured finance inst
  5. sec lending
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9
Q

Duration Matching

A
  • PVA > PVL
  • DA = DL (single liab)
  • BPVA = BPVL (multi liab)
  • min convexity

NO PASSIVE - rebalance regularly

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10
Q

Convexity

A

magnifies the upside and reduces the downside of price movement b/c changes in rates

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11
Q

Duration Gap

A

|BPVA - BPVL|

BPVA or L = Duration * Value * 0.0001

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12
Q

Futures Contracts Req to Close Duration Gap

A

Nfutures cont = duration gap / BPVfutures

BPVfutures = BPVCTD/ CFCTD

contracts = ( ΔD / Df ) * ( Vp / Vf )

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13
Q

Closing Duration Gap with Swap

A

NP = ΔBPV/ BPVswap

BPVswap = BPVrec - BPVpaid

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14
Q

Swaption

A

option to enter a swap, pay premium

  • payer swaption: SFRswaption < SFRnew; exercise
  • rec swaption: SFRswaption > SFRnew; exercise
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15
Q

Spread Risk

A

spread changes → rates cannot match; PV may not change as expected

example: portfolio yield and liab discount rate differ → diff risk levels

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16
Q

Controlling Risk of FI Bonds

A
  • match modified duration: control for parallel shifts of yield curve
  • match key rate duration: control for nonparallel shift of yield curve
  • match weighting to diff sectors and ratings
  • matching issuer exposure: control for firm specific event risk
17
Q

Portfolio Structures

A
  • bullet: conc in single middle duration
  • ladder: equal par amounts purchased, come due each year
  • barbell: conc in shorter and longer duration
18
Q

Cell Matching

A

matching the primary risk factor (duration) of the benchmark to minimize tracking error

19
Q

ETF

A

exchange traded fund

PROs: inc liquidity, price stability in maturing ETFs, inc convexity

20
Q

Stable Yield Curve Strategies

A
  1. buy and hold
  2. ride the yield curve: buy and sell, repeat
  3. carry trade
  4. sell convexity: buy/ sell options
21
Q

Parallel Shifts in Yield Curve Strategies

A
  • inc rates: dec duration
  • large movement: inc convexity (buy calls and puts, sell callable/ buy putable bonds, barbell portfolio)
22
Q

Nonparallel Shifts in Yield Curve Strategies

A
  • flatten: inc duration; barbell
  • steepen: dec duration; bullet
23
Q

Spreads

A
  • g-spread: YTMb - YTMOTR gb
  • i-spread: YTMb - YTMswap
  • z-spread: added to rf to get PVCF = price
  • OAS: z-spread for options
24
Q

Excess Return

A

s*t - Δs*Dspread - t*p*L

L = loss severity

CFA Level III (12 decks)

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