QFIP-153: Asset Allocation in a Low Yield Environment

Question 1

State how to decompose total return. Which metric is relevant for asset allocation optimization?

Answer 1

• Total Return = Risk-Free Rate + Excess Return
• Excess return is the relevant metric for asset allocation optimization

Question 2

Summarize the two regression results about lower yields from QFIP-153.

Answer 2

1. Lower yields are strongly associated with lower total returns
2. Lower yields do not have a clear relationship with lower excess returns

Question 3

State how to decompose bond excess returns

Answer 3

Bond Excess Returns = Term Premium + Capital Gain/Loss from Unexpected Changes in Yields

Question 4

Describe term premium and state how to (approximately) determine its value

Answer 4

• Term Premium - the excess return bond investors earn for taking duration risk
• Term premium is approx equal to yield curve slope