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FixedIncome Portfolio Management

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Duration Calculation: Example using Table 16.3. Irwin/McGraw-Hill. The McGraw-Hill ... Rule 6 The duration of a level annuity is equal to: Irwin/McGraw-Hill ... – PowerPoint PPT presentation

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Title: FixedIncome Portfolio Management


1
Chapter 16
  • Fixed-IncomePortfolio Management

2
Managing Fixed Income Securities Basic Strategies
  • Active strategy
  • Trade on interest rate predictions
  • Trade on market inefficiencies
  • Passive strategy
  • Control risk
  • Balance risk and return

3
Bond Pricing Relationships
  • Inverse relationship between price and yield
  • An increase in a bonds yield to maturity results
    in a smaller price decline than the gain
    associated with a decrease in yield
  • Long-term bonds tend to be more price sensitive
    than short-term bonds

4
Bond Pricing Relationships (contd)
  • As maturity increases, price sensitivity
    increases at a decreasing rate
  • Price sensitivity is inversely related to a
    bonds coupon rate
  • Price sensitivity is inversely related to the
    yield to maturity at which the bond is selling

5
Duration
  • A measure of the effective maturity of a bond
  • The weighted average of the times until each
    payment is received, with the weights
    proportional to the present value of the payment
  • Duration is shorter than maturity for all bonds
    except zero coupon bonds
  • Duration is equal to maturity for zero coupon
    bonds

6
Duration Calculation
7
Duration Calculation Example using Table 16.3
8
Duration/Price Relationship
  • Price change is proportional to duration and not
    to maturity
  • ?P/P -D x ?(1y) / (1y)
  • D modified duration
  • D D / (1y)
  • ?P/P - D x ?y

9
Rules for Duration
  • Rule 1 The duration of a zero-coupon bond equals
    its time to maturity
  • Rule 2 Holding maturity constant, a bonds
    duration is higher when the coupon rate is lower
  • Rule 3 Holding the coupon rate constant, a
    bonds duration generally increases with its time
    to maturity
  • Rule 4 Holding other factors constant, the
    duration of a coupon bond is higher when the
    bonds yield to maturity is lower

10
Rules for Duration (contd)
  • Rules 5 The duration of a level perpetuity is
    equal to
  • Rule 6 The duration of a level annuity is equal
    to

11
Rules for Duration (contd)
  • Rule 7 The duration for a corporate bond is
    equal to

12
Passive Management
  • Bond-Index Funds
  • Immunization of interest rate risk
  • Net worth immunization
  • Duration of assets Duration of liabilities
  • Target date immunization
  • Holding Period matches Duration
  • Cash flow matching and dedication

13
Duration and Convexity
Yield
14
Correction for Convexity
Correction for Convexity
15
Active Bond Management Swapping Strategies
  • Substitution swap
  • Intermarket swap
  • Rate anticipation swap
  • Pure yield pickup
  • Tax swap

16
Yield Curve Ride
Yield to Maturity
1.5 1.25 .75
Maturity
3 mon 6 mon 9 mon
17
Contingent Immunization
  • Combination of active and passive management
  • Strategy involves active management with a floor
    rate of return
  • As long as the rate earned exceeds the floor, the
    portfolio is actively managed
  • Once the floor rate or trigger rate is reached,
    the portfolio is immunized
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