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Dubai

Financial Market

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Published in: Business Finance | Finance: Corporate | Financial Management
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Portfolio Management The-Efficient-Market-Hypothesis

Namal I / Dubai

10 years of teaching experience

Qualification: BA(Economics)Special (Hons)(2nd Class). MA(Economics), MA(Financial Economics),M.Econ, MBA, PGD in Information Technology, MIT-Master of Information Technology, NVQ Level 4: Diploma in Computer Networking.

Teaches: Personality Development, Maths, Basic Computer, Computer Science, Economics, Business, Management Science, CMA, CIMA, IGCSE/AS/AL, Business Studies, Statistics, Management, Business Finance, Advanced Excel, Animation, CCNA Certification, Corel Draw, CSS Training, Digital Marketing, Dreamweaver, Facebook Applications, HTML Training, ICT Training, Illustrator, Joomla Training, MS Office, Networking, Photoshop, Video Editing, Web CMS, Web Designing, Web Development, Wordpress Training, Computer Basics, Desktop Publishing, Graphic Design, HTML, Powerpoint, Website Design, MS Access, Graphics, Hardware, Computer, Social Studies, Mathematics, Humanities Social Sciences

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  1. Managing Bond Portfolios
  2. Introduction • Fixed-income security management is largely a matter of altering the level of risk the portfolio faces: • Interest rate risk Default risk Reinvestment rate risk
  3. Passive Versus Active Management Strategies • Passive strategies Active strategies - Barbells and ladders - Forecasting interest rates - Taking advantage of mispricing.
  4. Passive Strategies Buy and hold • Indexing • Control risk • Balance risk and return
  5. Buy and Hold Bonds have a maturity date at which their investment merit ceases A passive bond strategy still requires the periodic replacement of bonds as they mature
  6. Indexing • Indexing involves an attempt to replicate the investment characteristics of a popular measure of the bond market The rationale for indexing is market efficiency Managers are unable to predict market movements and that attempts to time the market are fruitless A portfolio should be compared to an index of similar default and interest rate risk 6
  7. Bond Index Funds Table 16.4 Profile of bond indexes Number of issues Maturity of included bonds Excluded issues Weighting Reinvestment of intramonth cash flows Daily availability Lehman over 6,500 1 year Junk bonds Convertible bonds Floating-rate bonds Market value No Yes Merrill Lynch Over 5,000 1 year Junk bonds Convertible bonds Market value Yes (in specific bond) Salomon Smith Barney over 5,000 1 year Junk bonds Convertible bonds Floating-rate bonds Market value Yes (at I-month T-bill rate) Yes Australia: ABN AMRO* About 10-30 1 year Junk bonds Convertible bonds Market value Yes
  8. Immunization Net worth immunisation Duration of assets = Duration of liabilities • Immunize a portfolio by matching the interest rate exposure of assets and liabilities. • This means: Match the duration of the assets and liabilities. • Price risk and reinvestment rate risk exactly cancel out. Result: Value of assets will track the value of liabilities whether rates rise or fall. 16-8
  9. ctive Strategies • Trade on interest rate predictions • Trade on market inefficiencies Laddered portfolio Barbell portfolio Other active strategies 9
  10. Laddered Portfolio • In a laddered strategy, the fixed-income dollars are distributed throughout the yield curve • For example, a $1 million portfolio invested in bond maturities from 1 to 25 years (see next slide) 10
  11. Par Value Held ($ in Thousands) A)
  12. Barbell Portfolio • The barbell strategy differs from the laddered strategy in that less amount is invested in the middle maturities • For example, a $0.800 million portfolio invests $50,000 par value in bonds with maturities of 1 to 5 and 21 to 25 years, and $20,000 par value in bonds with maturities of 6 to 20 years (see next slide) 12
  13. Barbell Portfolio (cont'd) 50000 45000 40000 35000 30000 25000 20000 15000 10000 5000 1 3 5 7 9 11 13 15 17 Years Until Maturity 19 21 23 25 13
  14. Barbell Portfolio (cont'd) Managing a barbell portfolio is more complicated than managing a laddered portfolio • Each year, the manager must replace two sets of bonds: • The one-year bonds mature and the proceeds are used to buy 25-year bonds • The 21-year bonds become 20-years bonds, and $50,000 par value are sold and applied to the purchase of $50,000 par value of 5-year bonds 14
  15. Other Active Strategies • Identify bonds that are likely to experience a rating change in the near future An increase in bond rating pushes the price up A downgrade pushes the price down 15
  16. Risk of Barbells and Ladders • Interest rate risk Reinvestment rate risk Reconciling interest rate and reinvestment rate risks 16
  17. Interest Rate Risk Duration increases as maturity increases • The increase in duration is not linear Declining interest rates favor a laddered strategy • Increasing interest rates favor a barbell strategy 17
  18. Reinvestment Rate Risk The barbell portfolio requires a reinvestment each year of $70,000 par value The laddered portfolio requires the reinvestment each year of $40,000 par value Declining interest rates favor the laddered strategy, bonds constantly mature and can be invested in current rates. Rising interest rates favor the barbell strategy, as short term maturities can be quickly rolled over. Used when the gap between short and long rates are high. 18

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