POI – Bond Portfolio Management (T404)

Passive portfolio strategies
Strategy that usually has a lower rate of return. Usually done by indexing
Interest rate anticipation
Risky strategy that relies on uncertain forecasts. Objectives are met by adjusting portfolio’s duration based on expected interest rates
Barbell strategy
Splits funds between short duration and long duration securities. This is the longer form of the dumbbell strategy
Cushion bond
High-yielding, long term callable bond, whose price is kept down near its call price
Credit analysis
Requires investor to conduct a detailed analysis of potential changes in a firm’s default risk
Fallen angel
Bond that once was investment grade but has since fallen to junk bond status. These have lower default rates
Yield spread analysis
Analysis of departures from normal yield spreads as a basis for bond swaps
Bond swaps
Selling one bond and buying another simultaneously
Pure yield pick-up swap
Lower yielding bond is sold and a higher yielding bond is purchased. This usually increases the interest payment that is received
Substitution swap
Based on a short term disequilibrium in the yield spreads for two bonds that are perfect substitutes
Intermarket swap
Swap bonds that are no perfect substitutes (Treasuries for corporates)
Tax swap
Attempt to offset gains in one bond with the losses in another
Pure cash matched dedicated portfolio
Cash flows from all sources exactly match up in timing and size with the liability schedule
Dedication with reinvestment
Cash flows don’t exactly match the liability schedule. Considers the impact of reinvested cash flows to meet payment requirements
Horizon matching
Cash matching is used for the short-term while duration immunization is used for the long-term to make the duration of the bonds equal to the duration of the liabilities
Roll out
Occurs when the time horizon is pushed out one year further into the long term time horizon
Immunization strategies
Attempt to generate a specified rate of return regardless of what happens to market rates during investment horizon. Balances reinvestment risk with interest rate risk (price volatility)
Price volatility risk
If bond is sold prior to maturity, the selling price may be different from the expected par price if the bond was held to maturity
Reinvestment risk
Changes in interest rates change the rate at which cash flows can be reinvested
Contingent immunization
Allows for active management while assuring a minimal return. Management sets a floor rate of return
Cushion spread
Difference between market rates and the minimum that investors are willing to accept
Rate earned > floor rate
Sign of active management
Floor rate is reached
Portfolio is considered to be immunized