Schweser Cfa Level 3 2013
Another manager might be compared to a well-diversified bond index. Adjusting the dollar duration with this process is best demonstrated with an example.
To incorporate multifunctional duration into our immunization strategy, the manager focuses on certain key interest rate maturities. You will see in later study sessions that by using a derivatives overlay, the manager can tilt the portfolio toward or away from risk factors without changing the composition of the portfolio. Then the analyst determines what industries or sectors are expected to outperform and selects individual securities within those industries.
In other words, a twist entails a change in the overall shape of the yield curve. Dollar Duration The exposure can also be measured in terms of a dollar exposure, for which the dollar duration of the bond issue or sector is used instead of duration. Estimating duration, on the other hand, is quite straightforward and uses easily obtainable price, required return, and expected cash flow information. The final risk factor considered is issuer exposure, which is a measure of the index's event exposure. If a portfolio is to be rebalanced, it will be necessary to sell some of the bonds.
If yield is low on a relative basis, price is high. The duration contribution for the period is divided by the index duration i. Remember from studying duration that bond prices become less sensitive to interest rate changes as the maturity date nears. The timing and amounts of asset cash flows must also correspond to the liabilities.
Classic relative-value analysis combines the best bond investment opportunities using both the top-down and bottom-up approaches. Discuss the criteria for selecting a benchmark bond index and justify the selection of a specific index when given a description of an investor's risk aversion, income needs, and liabilities.
2013 CFA Level 1 - Book 5
Credit analysis Upgrades cause reduced yields and Identify credit upgrade and increased prices. It is the effective spread for the class after removing any embedded options. For example, a manager could Lock in a totally passive, risk-Less immunization by purchasing Treasury zeros with the same maturity as the liability.
Promadi is a trader and Cheung is a performance analyst. Although leverage can increase returns, it also has a downside. In this case, the required terminal value is determined by using the safety net return. The decline in trading activities that occurs during periods when performance reports and government filings are being prepared. Sinking funds provide for the early retirement of a portion of an issue of bonds.
The primary concern is exposure to risk factors. In other words, the manager who feels he has no reason to disagree with market forecasts has no reason to assume he can outperform an indexing strategy through active management. It is important to note that price risk and reinvestment rate risk cause opposite effects.
The focus here is that the control of cash flows is much more restrictive for cash flow matching than for immunization. For this reason, managers must use conservative assumptions. To help avoid interest rate risk, the manager will match the duration and convexity of the liability and the portfolio.
If this book does not have the hologram with the Kaplan Schweser logo on the back cover, it was distributed without permission of Kaplan Schweser, a Division of Kaplan, uc browser 8.2 for symbian Inc. Much of it should be familiar from earlier levels. The yield curve is expected to remain flat at its current level.
As the dispersion of the cash flows increases, so does the immunization risk. Primary market Supply of and demand for new issues When you expect rates to fall, you analysis affects returns. Concentrating the maturities of the bonds around the liability date is known as a bullet strategy. That is, bond portfolio management strategies form more or less a continuum from an almost do-nothing approach i. The procedure is to minimize a measure of immunization risk for multiple liabilities and nonparallel rate changes.
Due to the linear nature of duration, which causes it to underestimate the increase and overestimate the decrease in the value of the portfolio, the convexity effect is also considered. If the ratio is higher than justified by the historical ratio, the spread is expected to fall, making corporate bond prices rise. Lack of liquidity has also been cited as a reason for not trading. All three advantages are derived from the fact that there are low transactions costs and a great deal of depth in the futures market. The manager matches the weights of sectors and qualities in the index.
An important consideration in valuing bonds is that the difference between the prices of otherwise identical non-callable and callable bonds is the value of the embedded option. The typical broad bond market index contains thousands of issues with widely varying maturities, coupon rates, and bond sector coverage. Income risk varies indirectly with maturity. An immunized portfolio is only required to have sufficient value on the date of each liability.
Schweser CFA Level 3 Notes ( 3) by Kaplan Schweser
As long as that manager feels he can generate even greater returns, he should pursue active management in hopes of generating excess value. Instead, it measures only the dispersion of returns below a target return, which is the risk that most investors are concerned about. In addition, the manager might alter the duration of the portfolio somewhat. Note that in each case, relative phrases e. The move in debt markets has been toward increased liquidity i.
However, you are concerned about the effect that interest rate risk will have on the ending value of your portfolio. The new credit spread of bps is computed as the difference between the original credit spread of bps and the bps reduction in the spread at the horizon date.
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An alternative way to measure exposure is to measure the contribution of a sector or bond to the overall portfolio duration. Compare pure bond indexing, enhanced indexing, and active investing with respect to the objectives, advantages, disadvantages, and management of each. The analyst then determines what industries or sectors are expected to outperform and selects individual securities within those industries.
We have neglected to mention the relationship of risk minimization to the level of portfolio expected return. Be sure you know the difference and can discuss cyclical and secular changes. In derivatives, an alternate version based on duration and price of the contract will be used. If the liabilities are shorter term, the assets should also be shorter term. During the first few years, the portfolio would also be cash flow matched in order to make sure that assets were properly dispersed to meet the near-term obligations.
Thus far in our discussion of immunization strategies, we have not addressed the payment structure i. Just like bond prices, the prices of an interest rate futures contract will change when interest rates change. The effective duration for a bond index is computed in the same way as that for a bond portfolio.
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