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Risks and their measures
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- int. rate risk: portfolio duration
- yield curve risk: key rate duration and distribution of the PV of CFs
- spread risk: spread duration
- credit risk: contribution to duration by credit rating
- delta of the portfolio
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terms list
Risks and their measures
- int. rate risk: portfolio duration
- yield curve risk: key rate duration and distribution of the PV of CFs
- spread risk: spread duration
- credit risk: contribution to duration by credit rating
- delta of the portfolio
Risks of MBS
- sector risk
- prepayment risk
- convexity risk
Types of enhanced indexing strategies
- lower cost enhancement: maintaining tight control over trading cost and mgmt fee
- issue selection enhancement: identifying undervalued security with valuation models
- yield curve positioning: some maturities are constantly overvalued
- sector and quality positioning:
- call exposure positioning
Dollar duration
- duration*portfolio value*0.01
Immunization strategies
- classic single-period immunization
- contingent immunization
- multiple liability immunization
- CF matching
Horizon matching
- it creates a duration matched portfolio with the added constraint that it be CF-matched in the first few years
Spread duration calculation
- the weighted average duration of those securities that have a yield above the default-free yield (i.e., non-Treasuries)
conditions for multiple liability immunization
- A and L have the same PV
- A and L have the same aggregate duration
- the range of the distribution of duration of assets exceeds distribution of liabilities
* assumption is parallel shifts
Cash flow matching
- more stringent than immunization
- durations will be matched as time passes and rebalancing not needed
- using a series of bonds
Combination matching
- aka horizon matching
- duration matched, first few years would also be CF matched
- benefit: provide liquidity in initial period, reduce risk associated with nonparallel shifts in the yield curve
cushion spread
- aka excess achievable return
- current immunization rate - minimum acceptable return
yield curve-adj. trades
- LT rates are to fall, manager may shift into longer duration bonds
structure trade
- callable and putable bonds
- e.g.if rates are to fall, putable bonds tend to underperform nonputable issues
CF reinvestment trade
- if spread is to widen, buy short duration, sell longer duration
Percentage yield spread analysis
- the analysis divides the yields on corporate bonds by the yields on treasuries
bullet structure
- ST bullet: used on the short end of barbell (ST corporate+LT treasury)
- mid-term bullet: 20yr, most popular sector
- LT bullet: offering additional positive convexity at the cost of increased effective duration
cause for increasing trading based on CF reinvestment
- the primary supply is short or the composition of the primary market is not compatible with portfolio objectives
Bond risk measures
- stdev: 1) not normally distributed, 2) large # of inputs, 3)estimates hard to get;
- semivariance: not commonly used - 1) hard to compute on large portfolio, 2) if return is symmetric, it's the same as variance, 3) if not symmetric, can be hard to forecast, 4) using smaller sample size
- shortfall risk:does not consider the impact of outliers so the magnitude below return is ignored
- value at risk: does not provide the magnitude of losses beyond that specified by VAR
Relative value in bond market
- it refers to ranking credit sectors, bond structures, issuers, and issues in terms of their expected performance over some future time period
secular changes have 3 trends
3 structural changes are; securities with embedded options at a premium due to scarcity, longer durations at premium due to tendency toward intermediate term, and credit-based derivatives are increasingly used
types of secondary bond trades
- yield/spread pick-up, credit-upside trade, and credit-defense trade, and new issue swap, sector rotation trades, yield curve-adjustment trades, and structure trades (embedded options), and CF reinvestment trade
primary market analysis
- increase in new issues tend to decrease relative yields (when rates fall, new issues and refinances occur)
credit-defense strategy
- is used when there is concerns about economy slowing down
credit spread risk
- Credit spread risk is the risk of an increase in the yield spread on an asset. Yield spread is the asset's yield minus the relevant risk-free benchmark.
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