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LOS 20 - Fixed Income Portfolio Management - Part I
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Terms in this set (43)
Classification of Strategies
1. Pure bond indexing (or full replication approach)
2. Enhanced indexing by matching primary risk factors
3. Enhanced indexing by small risk factor mismatches
4. Active management by larger risk factor mismatches
5. Full-blown active management
Primary Risk Factors
Major influences on the pricing of bonds, such as changes in the level of interest rates, twists in the yield curve, and changes in the spread between Treasuries and non-Treasuries
Why Bond Indexing
a. Lower fees
b. Outperforming a broadly based market index on a consistent basis is a difficult task
c. Diversification
Yield Curve
The relationship between yield and time to maturity.
Twist of the Yield Curve
With respect to the yield curve, a movement in contrary directions of interest rates at two maturities - a nonparallel movement in the yield curve.
Risk Profile
A detailed tabulation of the index's risk exposures.
Interest Rate Risk
Risk related to changes in the level of interest rates.
Yield Curve Risk
Risk related to changes in the shape of the yield curve.
Spread Risk
Risk related to changes in the spread between Treasuries and non-Treasuries.
Cell-Matching Technique / Stratified Sampling
A portfolio construction technique used in indexing that divides the benchmark index into cells related to the risk factors affecting the index and samples from index securities belonging to those cells.
Multifactor Model Technique
With respect to construction of an indexed portfolio, a technique that attempts to match the primary risk exposures of the indexed portfolio to those of the index.
Effective Duration
Duration adjusted to account for embedded options.
Convexity Adjustment
An estimate of the change in price that is not explained by duration.
Key Rate Duration
A method of measuring the interest rate sensitivities of a fixed-income instrument or portfolio to shifts in key points along the yield curve.
Rate Duration
A fixed-income instrument's or portfolio's sensitivity to a change in key maturity, holding constant all other points along the yield curve.
Present Value Distribution of Cash Flows
A list showing what proportion of a portfolio's duration is attributable to each future cash flow.
Spread Duration
The sensitivity of a non-Treasury security's price to a widening or narrowing of the spread over Treasuries.
Tracking Risk
The standard deviation of the differences between a portfolio's returns and its benchmark's returns - a synonym of active risk. Also called tracking error.
Default Risk
The risk of loss if an issuer or counterparty does not fulfill its contractual obligations.
Total Return
The rate of return taking into account capital appreciation/depreciation and income. Often qualified as follows: Nominal returns are unadjusted for inflation - real returns are adjusted for inflation - pretax returns are returns before taxes - post-tax returns are returns after taxes are paid on investment income and realized capital gains.
Total Return Analysis
Analysis of the expected effect of a trade on the portfolio's total return, given an interest rate forecast.
Scenario Analysis
A risk management technique involving the examination of the performance of a portfolio under specified situations. Closely related to stress testing.
Immunization
An asset/liability management approach that structures investments in bonds to match (offset) liabilities' weighted-average duration - a type of dedication strategy.
Cash Flow Matching
An asset/liability management approach that provides the future funding of a liability stream from the coupon and matured principal payments of the portfolio. A type of dedication strategy.
Treasury Spot Curve
The term structure of Treasury zero coupon bonds.
Immunized Time Horizon
The time horizon over which a portfolio's value is immunized - equal to the portfolio duration.
Dollar Duration
A measure of the change in portfolio value for a 100 bps change in market yields.
Dollar duration = Duration × Portfolio value × 0.01
Rebalancing Ratio
A quantity involved in reestablishing the dollar duration of a portfolio to a desired level, equal to the original dollar duration divided by the new dollar duration.
Credit Risk
The risk of loss caused by a counterparty's or debtor's failure to make a timely payment or by the change in value of a financial instrument based on changes in default risk. Also called default risk.
Nominal Spread
The spread of a bond or portfolio above the yield of a Treasury of equal maturity.
Static Spread
The constant spread above the Treasury spot curve that equates the calculated price of the security to the market price. Also called zero-volatility spread.
Option-Adjusted Spread (OAS)
The current spread over the benchmark yield minus that component of the spread that is attributable to any embedded optionality in the instrument.
Functional Duration
The key rate duration. Also called multifunctional duration.
Contingent Immunization
A fixed-income strategy in which immunization serves as a fall-back strategy if the actively managed portfolio does not grow at a certain rate.
Cushion Spread
The difference between the minimum acceptable return and the higher possible immunized rate.
Economic Surplus
The market value of assets minus the present value of liabilities.
Barbell Portfolio
A portfolio made up of short and long maturities relative to the investment horizon date and interim coupon payments.
Bullet Portfolio
A portfolio made up of maturities that are very close to the investment horizon.
Maturity Variance
A measure of how much a given immunized portfolio differs from the ideal immunized portfolio consisting of a single pure discount instrument with maturity equal to the time horizon.
Linear Programming
Optimization in which the objective function and constraints are linear.
Confidence Interval
An interval that has a given probability of containing the parameter it is intended to estimate.
Symmetric Cash Flow Matching
A cash flow matching technique that allows cash flows occurring both before and after the liability date to be used to meet a liability - allows for the short-term borrowing of funds to satisfy a liability prior to the liability due date.
Combination Matching
A cash flow matching technique - a portfolio is duration-matched with a set of liabilities with the added constraint that it also be cash-flow matched in the first few years, usually the first five years. Also called horizon matching.
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