Managing Fixed Income Portfolios

Question 1

4 steps to a repo transaction

Answer 1

• broker sells fixed income security to third party.
• Simultaneously agrees to buy back the same security at set price on future date.
• Difference between repurchase price and sale price is borrowing cost for broker.
• Dealer uses borrowed funds trading purposes, and leverages size of portfolio.

Question 2

2 things to know about Passive bond management

Answer 2

• Minimizes effects of interest rate risk

* no attempt is made to predict the direction or magnitude of interest rates

Question 3

Interest rate risk affects investors in two ways

Answer 3

• Price Risk

* Reinvestment Rate risk

Question 4

What is Price risk?

Answer 4

Variation in market value

Question 5

what is Reinvestment Rate risk?

Answer 5

Chance that future proceeds will be reinvested at a lower future interest rate.

Question 6

3 applications of duration

Answer 6

• Determine average maturity
• Measures interest rate sensitivity
• immunizes against interest rate sensitivity

Question 7

For a bond portfolio, the sensitivity to interest rates is

Answer 7

modified duration

Question 8

five properties of a bond portfolio

Answer 8

1. A portfolio’s modified duration is the dollar-weighted sum of individual bond modified durations.
2. proportional change in a bond’s price following a yield change is the product of modified duration and the change in a bond’s yield to maturity.
3. the higher a bond’s coupon rate, the lower its modified duration.
4. the higher a bond’s yield to maturity, the lower its modified duration.
5. the longer a bond’s term to maturity, the greater its modified duration, except possibly when it is trading at a discount.

Question 9

two methods can be employed to replicate a bond index

Answer 9

• cellular / stratified, sampling

* Tracking Error Minimization

Question 10

What is a cellular portfolio

Answer 10

portfolio designed with cells in each of the three attributes: Coupon, Maturity, Credit Risk

Question 11

What is immunization?

Answer 11

can be viewed as a means of protecting a bond portfolio from interest rate risk

Question 12

How does a rate anticipation swap work?

Answer 12

• Funds are moved from one end of the yield curve to the other
• If interest rates are expected to fall, locking in higher rates for a longer period will be profitable

Question 13

How does a Bond swap work?

Answer 13

• Involve the purchase of one bond and the simultaneous sale of another bond.
• motivation for a fixed income swap is to profit from the correct analysis of the proper value of the yield spread between the two fixed income securities.

Question 14

How is a Barbell portfolio structured?

Answer 14

In a barbell portfolio, bonds are initially purchased at both ends of the term structure — that is, the portfolio consists of 30-year and one-year bonds.

Question 15

Target date immunization:

Answer 15

The need for a portfolio of fixed income instruments with a duration that matches the timing of the payout.

Question 16

Contingent immunization:

Answer 16

• The manager follows an active management strategy until a trigger point occurs.
• meaning the point where the portfolio’s value reaches the level at which a zero-coupon bond will mature to the target amount.

Question 17

Box trade:

Answer 17

• Involves the simultaneous execution of a pair of related fixed income security swaps.
• They are related in that the pair of swaps involves the securities of the same two bond issuers.

Question 18

Intermarket domestic box trade:

Answer 18

Involves four transactions of four domestically issued fixed income securities from two Canadian bond issuers.

Question 19

Intramarket box trade:

Answer 19

Type of box trade that involves bonds issued by the Canadian and U.S. governments.

Question 20

How does a laddered portfolio work?

Answer 20

• Each maturity purchased in equal amount up to 30 years
• when first year is up, 30th year becomes 29th
• proceeds from first year are reinvested in a new 30 year bond

Question 21

The indexes most often replicated in Canada are the

Answer 21

FTSE Global Debt Capital Markets

Question 22

What is immunization?

Answer 22

risk-mitigation strategy that matches the duration of assets and liabilities in order to minimize the impact of interest rates on net worth over time.

Question 23

horizon analysis.

Answer 23

choose a horizon over which the interest rate change is expected to evolve and at the end of which a new yield curve is predicted.
Swapping two bonds for that period entails a difference in price for the two bonds at the end of the horizon