Fixed Income Portfolios Flashcards
Compare Bond Indexing Strategies
Pure bond indexing
Enhanced indexing by matching primary risk factors
Enhanced indexing by small risk factor mismatches
Active management by larger risk factor mismatches
Full blown active management
Criteria for selecting a benchmark bond index
Four primary criteria Market value risk Income risk Credit risk Liability Framework risk (conditional)
Techniques to align risk exposure of portfolio with index
Duration
Key rate duration
Present value distribution of cash flow
Classical Immunization theory
Uses effective duration
Tries to minimize the interest rate risk
Tries to match loss from price risk with gain from reinvestment risk or vice versa
Rebalancing is necessary
Out of many portfolio that can be constructed, select the one with least immunization risk
Dollar Duration
-(modified or effective duration)(0.01)(price)
Reestablishing Dollar Duration
Calculate new Dollar Duration
Calculate rebalancing ratio - old DD/new DD
For rebalancing ratio -1 is multiplied with new market value to rebalance
Or, only one bond position can be changed
Importance of spread duration
Bond managers can adjust sector weightage to capture favorable spread changes Three types of spreads Nominal Zero volatility Option adjusted
Extensions made to classical immunization
Multifunctional Duration
Multiple liability immunization
Relaxation of minimum risk requirement
Contingent immunization
Risks associated with managing a portfolio against a liability structure
Interest rate risk
Contingent claim risk
Cap risk
wealth based taxes
taxes on real estate and transfers of wealth
progressive taxes
means that you are taxed on the dollars which fall into each bracket at that tax rate and then the following dollars at the higher rate
marginal tax rate
the rate at which the next dollar of income would be taxed
common progressive tax regime
progressive tax on income. favorable tax on interest dividends and capital gains.
heavy dividend regime
progressive for income. favorable for interest and cap gains. bad for dividends
heavy interst tax regime
tax progressive, interst and dividends favorabel. cap gains at marginal rate.
light capital gains
progressive tax system for ordinary income, favorable treatment of capital gains. normal of interest and dividends.
second most common type founds.
flat and light
flat tax and treats everything generally quite favorably
future value of investment subject to tax annually
FVST = [1 + r(1-t)]^n
how do annual taxes effect growth of invesment
stronger than the state tax rate
negative effects increase over time
tax drag increases as investment return increases
equation for return subject to tax at selling point. Normal cap gainst tax
(1+r)^n(1-t)+t=return
t = tax rate r = return
equation for including capital gains and cost basis
return in dollars= (1+r)^n(1-tcg)+tcgB
B=cost basis
tcg= tax on capital gains
wealth tax equation and what is it
tax on a certain level of wealth
return=(1+r)*(1-tw)^n
formula for retuns including taxes on interst dividends and cap gains
return after tax= pre tax return(1-piti-Pdtd-pcgtcg)
Pd= return div, pch= return cap gain pi=return interst.
t’s are respective tax rates
fut value of investment formula with defered cap gains
(1+r)^n(1-T)+T-(1-b)tcg
B=proportion of investment and tax basis. IE buy 100 dollar bond with 80 dollar tax basis B=.8
accrual equivalent retun
the return needed to generate the same amount of wealth if there were no taxes.
what is equiation for finding accrual equiv return
r*(1-T) = Rate
return rate pre tax * (1-tax rate)= return equivalent rate
tax deffered vs tax exempt accounts
tax deffered: (1+r)^n*(1-Tn)
Tn are taxes at time n. Obvi no taxes or tax exempt account you can remove 1-t protion
Do example 10 on page 238
its a good exercise
compare pre tax account and tax defferd account
only comparision is tax rate today vs tax rate before. They are the same if its taxed now or later only change in retun is the rate of tax.
how do taxes help with investment risk.
They absorb some of the pretax investment risk as you ahve a tax sheild on teh downside that has value.
tax alpha
the excess return generated by proper tax management strategies
generally where should bonds and equities be in terms of taxable and non taxable accounts
bonds should be held in tax exempt accounts and equities in tax paying accounts
how would tax rate on active investor vs passive investor differ
active would basically pay taxes annually because they trade in and out of positions during the year. Passive investor gets bennefit of Def tax cost because they hold their positions for over 1 year
tax loss harvesting
selling a loser to offset a gain
what is the cash flow benefit of realizing a loss earlier in the process
basically you have better net of tax cash flow and you have more money available for reinvestment
HIFO Tax basis
highest in first out. Means you can sell your equity lots with teh highest cost basis first and then use that deffered tax gain to yoru advantage
