OVERVIEW OF FIXED-INCOME PORTFOLIO MANAGEMENT

Question 1

Identify and explain types of bonds that offers an inflation hedge advantage :

Answer 1

inflation linked-bonds : Par of the bonds adjust for inflation. Thus, increase coupon payment since they are calculated on the par value of the bond. At expiration, inflation adjusted par is paid to the investor.

Floating-coupon : Enter a pay fixed, receive floating coupon.

Question 2

What are the immunization strategies that can be offered in LDI

Answer 2

Cash flow matching : Assets are selected so that cash flow occurs in size and at the time of the liability payouts

Duration matching : matches the duration of the assets and liabilities

Contingent immunization : Hybrid approach between active management approach and LDI.

Derivatives overlay : involving the use of futures or swaps contracts, can be used to implement duration matching or contingent immunization strategies.

Question 3

Identify the different types of approach of a total return fixed income mandate

Answer 3

1. Pure indexing
2. Enhanced indexing
3. Active management

Question 4

Contrast HY bonds vs IG bonds in terms of returns sensibility and how this affect the correlation with equity

Answer 4

HY bonds : more sensitive to changes in spread than changes in benchmark rates. Higher correlation with equity.

IG bonds : More sensitive to benchmark rate changes.

Question 5

How do we calculate the total returns of a leverage portfolio

Answer 5

Return on invested assets + (Amount of leverage/Amount of equity invested) * (Returns on invested assets - Borrowed rates)

Question 6

Explain fire sale risk created by leverage

Answer 6

If interest rates increase, the value of the leveraged portfolio and collateral will decline. This may induce money lenders to demand repayment and force liquidation of portfolio assets when they are down in value.

Question 7

Explain the advantages of using a laddered portfolio in cash-flow matching multiple liabilities

Answer 7

• Regular liquidity- some bonds are due each year
• Diversification of cash flow and yield curve across time
• Diversification between price risk and reinvestment risk
• Higher convexity, less than barbell portfolio tho.