Managing Fixed Income Portfolios Flashcards
4 steps to a repo transaction
- 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.
2 things to know about Passive bond management
- Minimizes effects of interest rate risk
* no attempt is made to predict the direction or magnitude of interest rates
Interest rate risk affects investors in two ways
- Price Risk
* Reinvestment Rate risk
What is Price risk?
Variation in market value
what is Reinvestment Rate risk?
Chance that future proceeds will be reinvested at a lower future interest rate.
3 applications of duration
- Determine average maturity
- Measures interest rate sensitivity
- immunizes against interest rate sensitivity
For a bond portfolio, the sensitivity to interest rates is
modified duration
five properties of a bond portfolio
- A portfolio’s modified duration is the dollar-weighted sum of individual bond modified durations.
- 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.
- the higher a bond’s coupon rate, the lower its modified duration.
- the higher a bond’s yield to maturity, the lower its modified duration.
- the longer a bond’s term to maturity, the greater its modified duration, except possibly when it is trading at a discount.
two methods can be employed to replicate a bond index
- cellular / stratified, sampling
* Tracking Error Minimization
What is a cellular portfolio
portfolio designed with cells in each of the three attributes: Coupon, Maturity, Credit Risk
What is immunization?
can be viewed as a means of protecting a bond portfolio from interest rate risk
How does a rate anticipation swap work?
- 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
How does a Bond swap work?
- 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.
How is a Barbell portfolio structured?
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.
Target date immunization:
The need for a portfolio of fixed income instruments with a duration that matches the timing of the payout.
Contingent immunization:
- 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.
Box trade:
- 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.
Intermarket domestic box trade:
Involves four transactions of four domestically issued fixed income securities from two Canadian bond issuers.
Intramarket box trade:
Type of box trade that involves bonds issued by the Canadian and U.S. governments.
How does a laddered portfolio work?
- 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
The indexes most often replicated in Canada are the
FTSE Global Debt Capital Markets
What is immunization?
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.
horizon analysis.
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
