Overview of Fixed-Income Portfolio Management Flashcards
(30 cards)
Roles of Fixed-Income Securities in Portfolios
- Diversification Benefits
- Benefits of Regular Cash Flows
- Inflation-Hedging Potential
Fixed-Income Mandates
Definition: Liability based
Liability-based mandates are investments that take an investor’s future obligations into consideration. Liability-based mandates are managed to match or cover expected liability payments (future cash outflows) with future projected cash inflows. As such, they are also referred to as asset/liability management (ALM) or mandates that use
liability-driven investments (LDIs).
Fixed-Income Mandates
Definition: Cash flow matching
Liability based - Cash flow matching
Cash flow matching is an immunization approach that attempts to ensure that all future liability payouts are matched precisely by cash flows from bonds or fixed-income derivatives.
Fixed-Income Mandates
Definition: Duration Matching
Liability based - Duration matching
Immunization approach based on the duration of assets and liabilities. Ideally, the liabilities being matched (the liability portfolio) and the portfolio of assets (the bond portfolio) should be affected similarly by a change in interest rates.
Fixed-Income Mandates
Definition: Derivatives Overlay
Liability based - Derivatives Overlay
The use of derivatives to achieve the same results
Fixed-Income Mandates
Definition: Contingent Immunization
Liability based - Contingent Immunization
Hybrid approach that combines immunization with an active management approach when the asset portfolio’s value exceeds the present value of the liability portfolio.
Fixed-Income Mandates
Definition: Total Return
Total return mandates are generally managed to either track or outperform a market-weighted fixed-income benchmark.
Fixed-Income Mandates
Definition: Pure Indexing
Total Return - Pure Indexing
Attempts to replicate a bond index as closely as possible, targeting zero active return and zero active risk.
Fixed-Income Mandates
Definition: Enhanced Indexing
Liability based - Enhanced Indexing
Maintains a close link to the benchmark but attempts to generate a modest amount of outperformance relative to the benchmark.
Fixed-Income Mandates
Definition: Active Management
Liability based - Active Management
A portfolio management approach that allows risk factor mismatches relative to a benchmark index causing potentially significant return differences between the active portfolio and the underlying benchmark.
Bond Risk and Return Measures
Definition: Macaulay Duration
Macaulay duration is a weighted average of the time to receipt of the bond’s promised payments, where the weights are the shares of the full price that correspond to each of the bond’s promised future payments.
Bond Risk and Return Measures
Definition: Modified Duration
The Macaulay duration statistic divided by one plus the yield per period, which estimates the percentage price change (including accrued interest) for a bond given a change in its yield to maturity.
Bond Risk and Return Measures
Definition: Effective Duration
The sensitivity of the bond’s price to a change in a benchmark yield curve (i.e., using a parallel shift in the benchmark yield curve (ΔCurve). Effective duration is essential to the measurement of the interest rate risk of a complex bond where future cash flows are uncertain.
Bond Risk and Return Measures
Definition: Key Rate Duration
Partial Duration
A measure of a bond’s sensitivity to a change in the benchmark yield curve at a specific maturity point or segment. Key rate durations help identify “shaping risk” for a bond or a portfolio—that is, its sensitivity to changes in the shape of the benchmark yield curve (e.g., the yield curve becoming steeper or flatter or showing more or less curvature).
Bond Risk and Return Measures
Definition: Empirical Duration
A measure of interest rate sensitivity that is determined from market data—that is, run a regression of bond price returns on changes in a benchmark interest rate (for example, the price returns of a 10-year euro-denominated corporate bond could be regressed on changes in the 10-year German bund or the 10-year Euribor swap rate).
Bond Risk and Return Measures
Definition: Money Duration
A measure of the price change in units of the currency in which the bond is denominated. Money duration can be stated per 100 of par value or in terms of the bond’s actual position size in the portfolio. Commonly called “dollar duration” in the United States
Bond Risk and Return Measures
Definition: PVBP
An estimate of the change in a bond’s price given a 1 bp change in yield to maturity. PVBP “scales” money duration so that it can be interpreted as money gained or lost for each basis point change in the reference interest rate.
Also referred to in North America as the “dollar value of an 0.01” (pronounced oh-one) and abbreviated as DV01. It is calibrated to a bond’s par value of 100; for example, a DV01 of $0.08 is equivalent to 8 cents per 100 points. (The terms PVBP and DV01 are used interchangeably; we will generally use PVBP, but DV01 has the same meaning).
A related statistic to PVBP, sometimes called “basis point value” (or BPV), is the money duration times 0.0001 (1 bp).
Bond Risk and Return Measures
Definition: Convexity
A second-order effect that describes a bond’s price behavior for larger yield movements. It captures the extent to which the yield/price relationship deviates from a linear relationship.
If a bond has positive convexity, the expected return of the bond will be higher than the return of an identical-duration, lower-convexity bond if interest rates change.
This price behavior is valuable to investors, and therefore, a bond with higher convexity might be expected to have a lower yield to maturity than a similar-duration bond with less convexity.
Nominal convexity calculations assume that the cash flows do not change when yields to maturity change.
Bond Risk and Return Measures
Definition: Effective Convexity
A curve convexity statistic that measures the secondary effect of a change in a benchmark yield curve. A pricing model is used to determine the new prices when the benchmark curve is shifted upward (PV+) and downward (PV−) by the same amount (ΔCurve), holding other factors constant.
Bond Risk and Return Measures
Definition: Bond Portfolio Duration
The sensitivity of a portfolio of bonds to small changes in interest rates. Recall that it can be calculated as the weighted average of time to receipt of the aggregate cash flows or, more commonly, as the weighted average of the individual bond durations of the portfolio.
Bond Risk and Return Measures
Definition: ModDur of Bond Portfolio
Indicates the percentage change in the market value given a change in yield to maturity. If the modified duration of a portfolio is 15, then for a 100 bp increase or decrease in yield to maturity, the market value of the portfolio is expected to decrease or increase by about 15%
Bond Risk and Return Measures
Definition: Convexity of Bond Portfolio
Can be a valuable tool when positioning a portfolio. Importantly, it is a second-order effect; it operates behind duration in importance and can largely be ignored for small yield changes. When convexity is added with the use of derivatives, however, it can be extremely important to returns. This effect will be demonstrated later. Negative convexity may also be an important factor in a bond’s or a portfolio’s returns. For bonds with short option positions embedded in their structures (such as mortgage-backed securities or callable bonds) or portfolios with short option positions, the convexity effect may be large
Bond Risk and Return Measures
Definition: Spread Duration
The change in bond price for a given change in yield spread. Also referred to as OAS duration when the option-adjusted spread (OAS) is the yield measure used.
Bond Risk and Return Measures
Definition: Duration Times Spread
Weighting of spread duration by credit spread in order to incorporate the empirical observation that spread changes for lower-rated bonds tend to be consistent on a percentage, rather than absolute, basis.
