Fixed Income Portfolios

Question 1

Compare Bond Indexing Strategies

Answer 1

Pure bond indexing
Enhanced indexing by matching primary risk factors
Enhanced indexing by small risk factor mismatches
Active management by larger risk factor mismatches
Full blown active management

Question 2

Criteria for selecting a benchmark bond index

Answer 2

Four primary criteria
Market value risk
Income risk
Credit risk
Liability Framework risk (conditional)

Question 3

Techniques to align risk exposure of portfolio with index

Answer 3

Duration
Key rate duration
Present value distribution of cash flow

Question 4

Classical Immunization theory

Answer 4

Uses effective duration
Tries to minimize the interest rate risk
Tries to match loss from price risk with gain from reinvestment risk or vice versa
Rebalancing is necessary
Out of many portfolio that can be constructed, select the one with least immunization risk

Question 5

Dollar Duration

Answer 5

-(modified or effective duration)(0.01)(price)

Question 6

Reestablishing Dollar Duration

Answer 6

Calculate new Dollar Duration
Calculate rebalancing ratio - old DD/new DD
For rebalancing ratio -1 is multiplied with new market value to rebalance
Or, only one bond position can be changed

Question 7

Importance of spread duration

Answer 7

Bond managers can adjust sector weightage to capture favorable spread changes
Three types of spreads
Nominal
Zero volatility
Option adjusted

Question 8

Extensions made to classical immunization

Answer 8

Multifunctional Duration
Multiple liability immunization
Relaxation of minimum risk requirement
Contingent immunization

Question 9

Risks associated with managing a portfolio against a liability structure

Answer 9

Interest rate risk
Contingent claim risk
Cap risk

Question 10

wealth based taxes

Answer 10

taxes on real estate and transfers of wealth

Question 11

progressive taxes

Answer 11

means that you are taxed on the dollars which fall into each bracket at that tax rate and then the following dollars at the higher rate

Question 12

marginal tax rate

Answer 12

the rate at which the next dollar of income would be taxed

Question 13

common progressive tax regime

Answer 13

progressive tax on income. favorable tax on interest dividends and capital gains.

Question 14

heavy dividend regime

Answer 14

progressive for income. favorable for interest and cap gains. bad for dividends

Question 15

heavy interst tax regime

Answer 15

tax progressive, interst and dividends favorabel. cap gains at marginal rate.

Question 16

light capital gains

Answer 16

progressive tax system for ordinary income, favorable treatment of capital gains. normal of interest and dividends.
second most common type founds.

Question 17

flat and light

Answer 17

flat tax and treats everything generally quite favorably

Question 18

future value of investment subject to tax annually

Answer 18

FVST = [1 + r(1-t)]^n

Question 19

how do annual taxes effect growth of invesment

Answer 19

stronger than the state tax rate
negative effects increase over time
tax drag increases as investment return increases

Question 20

equation for return subject to tax at selling point. Normal cap gainst tax

Answer 20

(1+r)^n(1-t)+t=return

t = tax rate r = return

Question 21

equation for including capital gains and cost basis

Answer 21

return in dollars= (1+r)^n(1-tcg)+tcgB
B=cost basis
tcg= tax on capital gains

Question 22

wealth tax equation and what is it

Answer 22

tax on a certain level of wealth

return=(1+r)*(1-tw)^n

Question 23

formula for retuns including taxes on interst dividends and cap gains

Answer 23

return after tax= pre tax return(1-piti-Pdtd-pcgtcg)
Pd= return div, pch= return cap gain pi=return interst.
t’s are respective tax rates

Question 24

fut value of investment formula with defered cap gains

Answer 24

(1+r)^n(1-T)+T-(1-b)tcg

B=proportion of investment and tax basis. IE buy 100 dollar bond with 80 dollar tax basis B=.8

Question 25

accrual equivalent retun

Answer 25

the return needed to generate the same amount of wealth if there were no taxes.

Question 26

what is equiation for finding accrual equiv return

Answer 26

r*(1-T) = Rate | return rate pre tax * (1-tax rate)= return equivalent rate

Question 27

tax deffered vs tax exempt accounts

Answer 27

tax deffered: (1+r)^n*(1-Tn) | Tn are taxes at time n. Obvi no taxes or tax exempt account you can remove 1-t protion

Question 28

Do example 10 on page 238

Answer 28

its a good exercise

Question 29

compare pre tax account and tax defferd account

Answer 29

only comparision is tax rate today vs tax rate before. They are the same if its taxed now or later only change in retun is the rate of tax.

Question 30

how do taxes help with investment risk.

Answer 30

They absorb some of the pretax investment risk as you ahve a tax sheild on teh downside that has value.

Question 31

tax alpha

Answer 31

the excess return generated by proper tax management strategies

Question 32

generally where should bonds and equities be in terms of taxable and non taxable accounts

Answer 32

bonds should be held in tax exempt accounts and equities in tax paying accounts

Question 33

how would tax rate on active investor vs passive investor differ

Answer 33

active would basically pay taxes annually because they trade in and out of positions during the year. Passive investor gets bennefit of Def tax cost because they hold their positions for over 1 year

Question 34

tax loss harvesting

Answer 34

selling a loser to offset a gain

Question 35

what is the cash flow benefit of realizing a loss earlier in the process

Answer 35

basically you have better net of tax cash flow and you have more money available for reinvestment

Question 36

HIFO Tax basis

Answer 36

highest in first out. Means you can sell your equity lots with teh highest cost basis first and then use that deffered tax gain to yoru advantage