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https://www.scribd.com/doc/104518183/22
06/09/2015
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CHAPTER TWENTYTWO
BOND PORTFOLIO
MANAGEMENT
2
BOND PORTOLIOS
• METHODS OF MANAGEMENT
– Passive
• rests on the belief that bond markets are semistrong
efficient
• current bond prices viewed as accurately reflecting
all publicly available information
3
BOND PORTOLIOS
• METHODS OF MANAGEMENT
– Active
• rests on the belief that the market is not so efficient
• some investors have the opportunity to earn above
average returns
4
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– for a typical bond making periodic coupon
payments and a terminal principal payment
5
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– THEOREM 1
• If a bond’s market price increases
• then its yield must decrease
• conversely if a bond’s market price decreases
• then its yield must increase
6
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– THEOREM 2
• If a bond’s yield doesn’t change over its life,
• then the size of the discount or premium will
decrease as its life shortens
7
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– THEOREM 3
• If a bond’s yield does not change over its life
• then the size of its discount or premium will
decrease
• at an increasing rate as its life shortens
8
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– THEOREM 4
• A decrease in a bond’s yield will raise the bond’s
price by an amount that is greater in size than the
corresponding fall in the bond’s price that would
occur if there were an equalsized increase in the
bond’s yield
• the priceyield relationship is convex
9
BOND PRICING THEOREMS
• 5 BOND PRICING THEOREMS
– THEOREM 5
• the percentage change in a bond’s price owing to a
change in its yield will be smaller if the coupon rate
is higher
10
CONVEXITY
CONVEXITY DEFINITION:
– a measure of the curvedness of the priceyield
relationship
11
CONVEXITY
• THE PRICEYIELD RELATIONSHIP
YTM
Price
12
CONVEXITY
• THEOREM 1 TELLS US
– price and yield are inversely related but not in a
linear fashion (see graph)
– an increase in yield is associated with a drop in
bond price
– but the size of the change in price when yield
rises is greater than the size of the price change
when yield falls
13
DURATION
• DEFINITION:
– measures the “average maturity” of a stream of
bond payments
– it is the weighted average time to full recovery
of the principal and interest payments
14
DURATION
• FORMULA
where P
0
= the current market price of
the bond
PV(C
t
)= the present value of the
coupon payments
t = time periods
¿
=
(
¸
(
¸
=
T
t
t
t
P
C PV
D
1
0
) (
15
DURATION
• THE RELATION OF DURATION TO
PRICE CHANGES
– THEOREM 5 implies
• bonds with same maturity date but different coupon
rates may react differently to changes in the interest
rate
• duration is a pricerisk indicator
16
DURATION
• DURATION IS A PRICERISK
INDICATOR
– FORMULA
rewritten
where y = the bond’s yield to maturity
  ) 1 ( ytm D
p
p
+ A ÷ ~
A


.

\

+
A
÷ ~
A
y
y
D
p
p
1
17
DURATION
• MODIFIED DURATION
– FORMULA:
– reflects the bond’s % price change for a one
percent change in the yield
y
D
D
m
+
=
1
18
DURATION
• THE RELATIONSHIP BETWEEN
CONVEXITY AND DURATION
– whereas duration would have us believe that the
relationship between yield and price change is
linear
– convexity shows us otherwise
19
DURATION
• THE RELATIONSHIP BETWEEN CONVEXITY AND DURATION
YTM
P
C
0
20
IMMUNIZATION
• DEFINITION: a bond portfolio
management technique which allows the
manager to be relatively certain of a given
promised cash stream
21
IMMUNIZATION
• HOW TO ACCOMPLISH
IMMUNIZATION
– Duration of a portfolio of bonds
• equals the weighted average of the individual bond
durations in the portfolio
– Immunization
• calculate the duration of the promised outflows
• invest in a portfolio of bonds with identical
durations
22
IMMUNIZATION
• PROBLEMS WITH IMMUNIZATION
– default and call risk ignored
– multiple nonparallel shifts in a nonhorizontal
yield curve
– costly rebalancing ignored
– choosing from a wide range of candidate bond
portfolios is not very easy
23
ACTIVE MANAGEMENT
• TYPES OF ACTIVE MANAGEMENT
– Horizon Analysis
• simple holding period selected for analysis
• possible yield structures at the end of period are
considered
• sensitivities to changes in key assumptions are
estimated
24
ACTIVE MANAGEMENT
• TYPES OF ACTIVE MANAGEMENT
– Bond Swapping
• exchanging bonds to take advantage of superior
ability to predict yields
• Categories:
– substitution swap
– intermarket spread swap
– rate anticipation swap
– pure yield pickup swap
25
ACTIVE MANAGEMENT
• TYPES OF ACTIVE MANAGEMENT
– Contingent Immunization
• portfolio managed actively as long as favorable
results are obtained
• if unfavorable, then immunize the portfolio
26
PASSIVE MANAGEMENT
• TYPES OF PASSIVE MANAGEMENT
– INDEXATION
• the portfolio is formed to track a chosen index
BOND PORTOLIOS
• METHODS OF MANAGEMENT
– Passive
• rests on the belief that bond markets are semistrong efficient • current bond prices viewed as accurately reflecting all publicly available information
2
BOND PORTOLIOS • METHODS OF MANAGEMENT – Active • rests on the belief that the market is not so efficient • some investors have the opportunity to earn aboveaverage returns 3 .
BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – for a typical bond making periodic coupon payments and a terminal principal payment 4 .
BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – THEOREM 1 • • • • If a bond’s market price increases then its yield must decrease conversely if a bond’s market price decreases then its yield must increase 5 .
• then the size of the discount or premium will decrease as its life shortens 6 .BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – THEOREM 2 • If a bond’s yield doesn’t change over its life.
BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – THEOREM 3 • If a bond’s yield does not change over its life • then the size of its discount or premium will decrease • at an increasing rate as its life shortens 7 .
BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – THEOREM 4 • A decrease in a bond’s yield will raise the bond’s price by an amount that is greater in size than the corresponding fall in the bond’s price that would occur if there were an equalsized increase in the bond’s yield • the priceyield relationship is convex 8 .
BOND PRICING THEOREMS • 5 BOND PRICING THEOREMS – THEOREM 5 • the percentage change in a bond’s price owing to a change in its yield will be smaller if the coupon rate is higher 9 .
CONVEXITY CONVEXITY DEFINITION: – a measure of the curvedness of the priceyield relationship 10 .
CONVEXITY • THE PRICEYIELD RELATIONSHIP Price YTM 11 .
CONVEXITY • THEOREM 1 TELLS US – price and yield are inversely related but not in a linear fashion (see graph) – an increase in yield is associated with a drop in bond price – but the size of the change in price when yield rises is greater than the size of the price change when yield falls 12 .
DURATION • DEFINITION: – measures the “average maturity” of a stream of bond payments – it is the weighted average time to full recovery of the principal and interest payments 13 .
DURATION • FORMULA PV (Ct ) D P t 1 0 T t where P0 = the current market price of the bond PV(Ct )= the present value of the coupon payments t = time periods 14 .
DURATION • THE RELATION OF DURATION TO PRICE CHANGES – THEOREM 5 implies • bonds with same maturity date but different coupon rates may react differently to changes in the interest rate • duration is a pricerisk indicator 15 .
DURATION • DURATION IS A PRICERISK INDICATOR – FORMULA p D(1 ytm) p rewritten y p D 1 y p where y = the bond’s yield to maturity 16 .
DURATION • MODIFIED DURATION D – FORMULA: Dm 1 y – reflects the bond’s % price change for a one percent change in the yield 17 .
DURATION • THE RELATIONSHIP BETWEEN CONVEXITY AND DURATION – whereas duration would have us believe that the relationship between yield and price change is linear – convexity shows us otherwise 18 .
DURATION • THE RELATIONSHIP BETWEEN CONVEXITY AND DURATION P C 0 YTM 19 .
IMMUNIZATION • DEFINITION: a bond portfolio management technique which allows the manager to be relatively certain of a given promised cash stream 20 .
IMMUNIZATION • HOW TO ACCOMPLISH IMMUNIZATION – Duration of a portfolio of bonds • equals the weighted average of the individual bond durations in the portfolio – Immunization • calculate the duration of the promised outflows • invest in a portfolio of bonds with identical durations 21 .
IMMUNIZATION • PROBLEMS WITH IMMUNIZATION – default and call risk ignored – multiple nonparallel shifts in a nonhorizontal yield curve – costly rebalancing ignored – choosing from a wide range of candidate bond portfolios is not very easy 22 .
ACTIVE MANAGEMENT • TYPES OF ACTIVE MANAGEMENT – Horizon Analysis • simple holding period selected for analysis • possible yield structures at the end of period are considered • sensitivities to changes in key assumptions are estimated 23 .
ACTIVE MANAGEMENT • TYPES OF ACTIVE MANAGEMENT – Bond Swapping • exchanging bonds to take advantage of superior ability to predict yields • Categories: – – – – substitution swap intermarket spread swap rate anticipation swap pure yield pickup swap 24 .
ACTIVE MANAGEMENT • TYPES OF ACTIVE MANAGEMENT – Contingent Immunization • portfolio managed actively as long as favorable results are obtained • if unfavorable. then immunize the portfolio 25 .
PASSIVE MANAGEMENT • TYPES OF PASSIVE MANAGEMENT – INDEXATION • the portfolio is formed to track a chosen index 26 .
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