Overview of Fixed Income Portfolio Management Flashcards
What are the roles of Fixed-Income in PM ?
Diversification, regular CF, Possible inflation hedge (TIPS)
How to Classify Fixed-Income mandate ?
Liability-based mandate
Total return Mandate
What are the types of Liability-based mandate ?
CF-matching
Duration-matching
What is immunization approach in Fixed-Income ?
immunization is the process of structuring and managing a fixed income portfolio to minimize the variance between the realized rate of return over the known period.
Elaborate on CF-matching
In Practice it is difficult to have to find a bond with a perfect match with the liabilities using the CF-matching, the change interest rate environment will prompt rebalances.
Elaborate on Duration-matching
- The bond portfolio duration must be equal the duration of the liabilities
- The Pv of the bond portfolio must equal the Pv of liabilities at current interest rate level.
What are the limitations of the duration immunization ?
- Protects against parallel shift of yield curve not changes the shape or slope.
- The need to rebalance makes liquidity consideration important
- immunization does not account for specific credit risk
*For bond with option, use effective durations instead of MD.
What is contingent immunization ?
Combines immunization with an active management. When the assets value exceed liabilities, the excess portion can be reinvested and managed actively.
What is horizon matching ?
Combines CF-matching to Duration-matching. The liabilities are divided into two portions, the short-term (0-5) and CF-matched and long-term are duration-matched. This approach combines desirable features of both CF and duration matching.
Elaborate on total return mandate
Objectives are linked to absolute or relative return. Active risk and active return represent key metrics.
Define:
- Pure indexing
- Enhanced indexing
- Active management
- Pure indexing: Attempt to replicate and track an index. Can prove costly and experience several constraints such as liquidity.
- Enhanced indexing: Trade loosely around an index in an attempt to generate at least a modest amount of outperformance relative to the benchmark.
- Active management allows larger risk factors mismatches relative to the benchmark index in pursuit of superior return.
What are the alternatives to direct investment in Bonds
Options on Futures, futures, Swaps.
Decomposition of expected returns:
E(R)= Yield income
\+ Roll down return
\+ (change view of PM in spread)
- (Credit losses)
\+ (Currency gain or losses)
Roll down yield= (Bond price T1 - Bond price T0)/(Bond price T0)
change view of PM in spread = (-MD * change in yield) + (1/2 convexity * change in yield^2)
For bond with embed options used effective duration and effective convexity.
What are the limitations of expected returns decomposition ?
It assumes constant YTM and ignores local richness cheapness effects.
Compute return in light of leverage
Rp = Portfolio return / Portfolio Equity
Rp = Ri + VB/VE(Ri-RB)
Ri: Portfolio return
RB. Costs of borrowed funds.
