Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Editi

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Lecture Presentation Software to
accompanyInvestment Analysis and Portfolio
ManagementEighth Editionby Frank K. Reilly
Keith C. Brown
Chapter 19

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Chapter 19 - Bond Portfolio Management Strategies

• Questions to be answered
• What are the four major bond portfolio management
  strategies?
• What are the two passive portfolio management
  strategies available?

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Chapter 19 - Bond Portfolio Management Strategies

• What are the five active bond portfolio
  management strategies available?
• What is meant by care-plus bond management and
  what are some plus strategies?
• What is meant by matched-funding techniques, and
  what are the four specific strategies available
  in this category?

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Chapter 19 - Bond Portfolio Management Strategies

• What are the major contingent procedure
  strategies that are also referred to as
  structured active management strategies?
• What are the implications of capital market
  theory for those involved in bond portfolio
  management?

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Chapter 19 - Bond Portfolio Management Strategies

• What is the evidence on the efficient market
  hypothesis as it relates to bond markets?
• What are the implications of efficient market
  studies for bond portfolio managers?

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Alternative Bond Portfolio Strategies

• 1. Passive portfolio strategies
• 2. Active management strategies
• 3. Core-plus management strategy
• 3. Matched-funding techniques
• 4. Contingent procedure (structured active
  management)

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Passive Portfolio Strategies

• Buy and hold
• A manager selects a portfolio of bonds based on
  the objectives and constraints of the client with
  the intent of holding these bonds to maturity
• Indexing
• The objective is to construct a portfolio of
  bonds that will equal the performance of a
  specified bond index

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Active Management Strategies

• Interest-rate anticipation
• Risky strategy relying on uncertain forecasts
• Ladder strategy staggers maturities
• Barbell strategy splits funds between short
  duration and long duration securities
• Valuation analysis
• The portfolio manager attempts to select bonds
  based on their intrinsic value
• Credit analysis
• Involves detailed analysis of the bond issuer to
  determine expected changes in its default risk

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Active Management Strategies

• High-Yield Bond Research
• Several investment houses such as Merrill Lynch,
  First Boston, Lehman Brothers, etc., have
  developed specialized high-yield groups that
  examine high-yield bond issues and monitor
  high-yield bond spreads
• Yield spread analysis
• Assumes normal relationships exist between the
  yields for bonds in alternative sectors
• Bond swaps
• Involve liquidating a current position and
  simultaneously buying a different issue in its
  place with similar attributes but having a chance
  for improved return

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Bond Swaps

• Pure Yield Pickup Swap
• Substitution Swap
• Tax Swap
• Swap strategies and market-efficiency
• Bond swaps by their nature suggest market
  inefficiency

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A Global Fixed-Income Investment Strategy

• Factors to consider
• The local economy in each country including the
  effects of domestic and international demand
• The impact of total demand and domestic monetary
  policy on inflation and interest rates
• The effect of the economy, inflation, and
  interest rates on the exchange rates among
  countries

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Core-Plus Bond Portfolio Management

• This involves having a significant (core) part of
  the portfolio managed passively in a widely
  recognized sector such as the U.S. Aggregate
  Sector or the U.S. Government/Corporate sector.
• The rest of the portfolio would be managed
  actively in one or several additional plus
  sectors, where it is felt that there is a higher
  probability of achieving positive abnormal rates
  of return because of potential inefficiencies

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Matched-Funding Techniques

• Dedicated Portfolios
• Dedication refers to bond portfolio management
  techniques that are used to service a prescribed
  set of liabilities
• Pure Cash-Matched Dedicated Portfolios
• Most conservative strategy
• Dedication With Reinvestment
• Cash flows do not have to exactly match the
  liability stream

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Matched-Funding Techniques

• Immunization Strategies
• A portfolio manager (after client consultation)
  may decide that the optimal strategy is to
  immunize the portfolio from interest rate changes
• The immunization techniques attempt to derive a
  specified rate of return during a given
  investment horizon regardless of what happens to
  market interest rates

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Immunization Strategies

• The process intended to eliminate interest rate
  risk is referred to as interest rate risk
• Components of Interest Rate Risk
• Price Risk
• Coupon Reinvestment Risk

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Classical Immunization

• Immunization is neither a simple nor a passive
  strategy
• An immunized portfolio requires frequent
  rebalancing because the modified duration of the
  portfolio always should be equal to the remaining
  time horizon (except in the case of the
  zero-coupon bond)

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Classical Immunization

• Duration characteristics
• Duration declines more slowly than term to
  maturity, assuming no change in market interest
  rates
• Duration changes with a change in market interest
  rates
• There is not always a parallel shift of the yield
  curve
• Bonds with a specific duration may not be
  available at an acceptable price

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Matched-Funding Techniques

• Horizon matching
• Combination of cash-matching dedication and
  immunization
• Important decision is the length of the horizon
  period

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Contingent Procedures

• A form of structured active management
• Constrains the manager if unsuccessful
• Contingent immunization
• duration of portfolio must be maintained at the
  horizon value
• cushion spread is potential return below current
  market
• safety margin
• trigger point

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Implications of Capital Market Theory and the EMH
on Bond Portfolio Management

• Bonds and Total Portfolio Theory
• Bonds and Capital Market Theory
• Bond Price Behavior in a CAPM Framework
• Bond-Market Efficiency

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The InternetInvestments Online

• http//www.ryanalm.com
• http//www.cmsbondedge.com
• http//smithbarney.com/research/fixed_income.html
• http//www.smithbarney.com/products_services/fixed
  _income/
• http//www.bergencapital.com/research/files/Ladder
  edPortfolio.html
• http//www.askmerrill.ml.com/investments/
• http//www.mlim.ml.com/usa/
• http//www.finpipe.com

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• End of Chapter 19
• Bond Portfolio Management Strategies

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Future topicsChapter 20

• An Introduction to Derivative Markets and
  Securities