Question 1

The following information relates to Questions 
Doug Kepler, the newly hired chief financial officer for the City of radford, asks the dep-uty financial manager, hui ng, to prepare an analysis of the current investment portfolio and the city's current and future obligations. The city has multiple liabilities of different amounts and maturities relating to the pension fund, infrastructure repairs, and various other obligations. ng observes that the current fixed-income portfolio is structured to match the duration of each liability. Previously, this structure caused the city to access a line of credit for temporary mismatches resulting from changes in the term structure of interest rates.
Kepler asks ng for different strategies to manage the interest rate risk of the city's fixed-income investment portfolio against one-time shifts in the yield curve. ng considers two different strategies:
Strategy 1: immunization of the single liabilities using zero-coupon bonds held to maturity.
Strategy 2: immunization of the single liabilities using coupon-bearing bonds while continuously matching duration. The city also manages a separate, smaller bond portfolio for the radford School District. During the next five years, the school district has obligations for school expansions and ren- ovations. The funds needed for those obligations are invested in the loomberg barclays US aggregate index. Kepler asks ng which portfolio management strategy would be most efficient in mimicking this index.
a radford School board member has stated that she prefers a bond portfolio structure that provides diversification over time, as well as liquidity. in addressing the board member's
inquiry, ng examines a bullet portfolio, a barbell portfolio, and a laddered portfolio.
-ng's response to Kepler's question about the most efficient portfolio management strategy should be:
A) full replication.
B) active management.
C) a stratified sampling approach to indexing.

Accepted Answer

A stratified sampling approach to indexing would be the most efficient portfolio management strategy for mimicking the Loomberg Barclays US Aggregate Index. This approach allows for the selection of a representative sample of securities that closely matches the characteristics of the index, while also providing the benefits of diversification and liquidity that the school board member desires. Active management or full replication may be too costly or impractical for the city's bond portfolio.

Question 2

The following information relates to Questions
Chaopraya av is an investment advisor for high-net-worth individuals. one of her clients,Schuylkill Cy, plans to fund her grandson's college education and considers two options:
option 1 Contribute a lump sum of $300,000 in 10 years.
option 2 Contribute four level annual payments of $76,500 starting in 10 years.The grandson will start college in 10 years. Cy seeks to immunize the contribution today.For option 1, av calculates the present value of the $300,000 as $234,535. to immunize the future single outflow, av considers three bond portfolios given that no zero-coupon govern- ment bonds are available. The three portfolios consist of non-callable, fixed-rate, coupon-bearing government bonds considered free of default risk. av prepares a comparative analysis of the three portfolios, presented in exhibit 1.
 $$\begin{array}{l}
\text { EXHIBIT } 1 \text { Results of Comparative Analysis of Potential Portfolios }\
\begin{array} { l c c c } 
\hline & \text { Portfolio A } & \text { Portfolio B } & \text { Portfolio C } \
\hline \text { Market value } & \$ 235,727 & \$ 233,428 & \$ 235,306 \
\text { Cash flow yield } & 2.504 \% & 2.506 \% & 2.502 \% \
\text { Macaulay duration } & 9.998 & 10.002 & 9.503 \
\text { Convexity } & 119.055 & 121.498 & 108.091 \
\hline
\end{array}
\end{array}$$ 
av evaluates the three bond portfolios and selects one to recommend to Cy.
-Determine the most appropriate immunization portfolio in exhibit 2. Justify your decision. $\text {Template for Question 25}$
$\text {Determine the most appropriate}$
$\text { immunization portfolio in Exhibit 2.}$

$\begin{array}{llcc}
\text {(circle one)} & \text { Justify your decision. }  \
  \hline  \text {Portfolio 1  } &\
 \text {Portfolio 2  } &\
 \text { Portfolio 3 } &\
  \hline
\end{array}$

after selecting a portfolio to immunize Cy's multiple future outflows, av prepares a report on how this immunization strategy would respond to various interest rate scenarios. The sce-nario analysis is presented in exhibit 3. $$\begin{array}{l}
\text { EXHIBIT } 3 \text { Projected Portfolio Response to Interest Rate Scenarios }\
\begin{array} { l c c c } 
\hline & \text { Immunizing Portfolio } & \text { Outflow Portfolio } & \text { Difference } \
\hline \text { Upward parallel shift } & & &\
\Delta \text { Market value } & - 6,410 & - 6,427 &18 \
\Delta \text { Cash flow yield } & 0.250 \% & 0.250 \% & 0.000\% \
\Delta \text { Portfolio BPV } & - 9 & - 8 & -1 \
\text { Downwardparallel shift } & & & \
\Delta \text { Market value } & 6,626 & 6,622 &4
\end{array}
\end{array}$$ $$\begin{array} { l c c c } 
\hline & \text { Immunizing Portfolio } & \text { Outflow Portfolio } & \text { Difference } \
\hline \Delta \text { Cash flow yield } & - 0.250 \% & - 0.250 \% & 0.000 \% \
\Delta \text { Portfolio BPV } & 9 & 8 & 1 \
\text { Steepening twist } & & & \
\Delta \text { Market value } & - 1,912 & 347 & - 2,259 \
\Delta \text { Cash flow yield } & 0.074 \% & - 0.013 \% & 0.087 \% \
\Delta \text { Portfolio BPV } & - 3 & 0 & - 3 \
\text { Flattening twist } & & & \
\Delta \text { Market value } & 1,966 & - 343 & 2,309 \
\Delta \text { Cash flow yield } & - 0.075 \% & 0.013 \% & - 0.088 \% \
\Delta \text { Portfolio BPV } & 3 & 0 & 3 \
\hline
\end{array}$$

Accepted Answer

The answer of The following information relates to Questions
Chaopraya av...

Question 3

The following information relates to Questions
Chaopraya av is an investment advisor for high-net-worth individuals. one of her clients,Schuylkill Cy, plans to fund her grandson's college education and considers two options:
option 1 Contribute a lump sum of $300,000 in 10 years.
option 2 Contribute four level annual payments of $76,500 starting in 10 years.The grandson will start college in 10 years. Cy seeks to immunize the contribution today.For option 1, av calculates the present value of the $300,000 as $234,535. to immunize the future single outflow, av considers three bond portfolios given that no zero-coupon govern- ment bonds are available. The three portfolios consist of non-callable, fixed-rate, coupon-bearing government bonds considered free of default risk. av prepares a comparative analysis of the three portfolios, presented in exhibit 1.
 $$\begin{array}{l}
\text { EXHIBIT } 1 \text { Results of Comparative Analysis of Potential Portfolios }\
\begin{array} { l c c c } 
\hline & \text { Portfolio A } & \text { Portfolio B } & \text { Portfolio C } \
\hline \text { Market value } & \$ 235,727 & \$ 233,428 & \$ 235,306 \
\text { Cash flow yield } & 2.504 \% & 2.506 \% & 2.502 \% \
\text { Macaulay duration } & 9.998 & 10.002 & 9.503 \
\text { Convexity } & 119.055 & 121.498 & 108.091 \
\hline
\end{array}
\end{array}$$ 
av evaluates the three bond portfolios and selects one to recommend to Cy.
-Discuss the effectiveness of av's immunization strategy in terms of duration gaps.

Accepted Answer

The answer of The following information relates to Questions
Chaopraya av...

Question 4

The following information relates to Questions
Chaopraya av is an investment advisor for high-net-worth individuals. one of her clients,Schuylkill Cy, plans to fund her grandson's college education and considers two options:
option 1 Contribute a lump sum of $300,000 in 10 years.
option 2 Contribute four level annual payments of $76,500 starting in 10 years.The grandson will start college in 10 years. Cy seeks to immunize the contribution today.For option 1, av calculates the present value of the $300,000 as $234,535. to immunize the future single outflow, av considers three bond portfolios given that no zero-coupon govern- ment bonds are available. The three portfolios consist of non-callable, fixed-rate, coupon-bearing government bonds considered free of default risk. av prepares a comparative analysis of the three portfolios, presented in exhibit 1.
 $$\begin{array}{l}
\text { EXHIBIT } 1 \text { Results of Comparative Analysis of Potential Portfolios }\
\begin{array} { l c c c } 
\hline & \text { Portfolio A } & \text { Portfolio B } & \text { Portfolio C } \
\hline \text { Market value } & \$ 235,727 & \$ 233,428 & \$ 235,306 \
\text { Cash flow yield } & 2.504 \% & 2.506 \% & 2.502 \% \
\text { Macaulay duration } & 9.998 & 10.002 & 9.503 \
\text { Convexity } & 119.055 & 121.498 & 108.091 \
\hline
\end{array}
\end{array}$$ 
av evaluates the three bond portfolios and selects one to recommend to Cy.
-Recommend the portfolio in exhibit 1 that would best achieve the immunization. Justify your response. Template :
Recommend the portfolio in exhibit 1 that would best achieve the immunization. (circle one) Justify your response. Portfolio a Portfolio b Portfolio C Cy and av now discuss option 2.av estimates the present value of the four future cash flows as $230,372, with a money duration of $2,609,700 and convexity of 135.142. She considers three possible portfolios to
immunize the future payments, as presented in exhibit 2. EXHIBIT 2
Data for Bond Portfolios to Immunize Four Annual Contributions
$\begin{array}{llll} 
\hline & \text { Portfolio 1 } & \text { Portfolio 2 } & \text { Portfolio 3 } \
\hline \text { Market value } & \$ 245,178 & \$ 248,230 & \$ 251,337 \
\text { Cash flow yield } & 2.521 \% & 2.520 \% & 2.516 \% \
\text { Money duration } & 2,609,981 & 2,609,442 & 2,609,707 \
\text { Convexity } & 147.640 & 139.851 & 132.865\
\hline
\end{array}$

Accepted Answer

The answer of The following information relates to Questions
Chaopraya av...

Question 5

The following information relates to Questions 
Doug Kepler, the newly hired chief financial officer for the City of radford, asks the dep-uty financial manager, hui ng, to prepare an analysis of the current investment portfolio and the city's current and future obligations. The city has multiple liabilities of different amounts and maturities relating to the pension fund, infrastructure repairs, and various other obligations. ng observes that the current fixed-income portfolio is structured to match the duration of each liability. Previously, this structure caused the city to access a line of credit for temporary mismatches resulting from changes in the term structure of interest rates.
Kepler asks ng for different strategies to manage the interest rate risk of the city's fixed-income investment portfolio against one-time shifts in the yield curve. ng considers two different strategies:
Strategy 1: immunization of the single liabilities using zero-coupon bonds held to maturity.
Strategy 2: immunization of the single liabilities using coupon-bearing bonds while continuously matching duration. The city also manages a separate, smaller bond portfolio for the radford School District. During the next five years, the school district has obligations for school expansions and ren- ovations. The funds needed for those obligations are invested in the loomberg barclays US aggregate index. Kepler asks ng which portfolio management strategy would be most efficient in mimicking this index.
a radford School board member has stated that she prefers a bond portfolio structure that provides diversification over time, as well as liquidity. in addressing the board member's
inquiry, ng examines a bullet portfolio, a barbell portfolio, and a laddered portfolio.
-The effects of a non-parallel shift in the yield curve on Strategy 2 can be reduced by:
A) minimizing the convexity of the bond portfolio.
B) maximizing the cash flow yield of the bond portfolio.
C) minimizing the difference between liability duration and bond-portfolio duration.

Accepted Answer

Minimizing the convexity of the bond portfolio will reduce the effects of a non-parallel shift in the yield curve on Strategy 2. Convexity measures the curvature of the relationship between bond prices and interest rates, and a higher convexity means that bond prices are more sensitive to changes in interest rates. By minimizing convexity, the bond portfolio will be less sensitive to changes in interest rates, which will reduce the impact of a non-parallel shift in the yield curve.

Question 6

The following information relates to Questions 
Doug Kepler, the newly hired chief financial officer for the City of radford, asks the dep-uty financial manager, hui ng, to prepare an analysis of the current investment portfolio and the city's current and future obligations. The city has multiple liabilities of different amounts and maturities relating to the pension fund, infrastructure repairs, and various other obligations. ng observes that the current fixed-income portfolio is structured to match the duration of each liability. Previously, this structure caused the city to access a line of credit for temporary mismatches resulting from changes in the term structure of interest rates.
Kepler asks ng for different strategies to manage the interest rate risk of the city's fixed-income investment portfolio against one-time shifts in the yield curve. ng considers two different strategies:
Strategy 1: immunization of the single liabilities using zero-coupon bonds held to maturity.
Strategy 2: immunization of the single liabilities using coupon-bearing bonds while continuously matching duration. The city also manages a separate, smaller bond portfolio for the radford School District. During the next five years, the school district has obligations for school expansions and ren- ovations. The funds needed for those obligations are invested in the loomberg barclays US aggregate index. Kepler asks ng which portfolio management strategy would be most efficient in mimicking this index.
a radford School board member has stated that she prefers a bond portfolio structure that provides diversification over time, as well as liquidity. in addressing the board member's
inquiry, ng examines a bullet portfolio, a barbell portfolio, and a laddered portfolio.
-Which portfolio structure should ng recommend that would satisfy the school board member's preference?
A) bullet portfolio
B) barbell portfolio
C) Laddered portfolio

Accepted Answer

The laddered portfolio provides diversification over time by staggering the maturity dates of the bonds held in the portfolio. It also allows for liquidity by having bonds maturing at regular intervals. This would satisfy the School Board member's preference.

Quiz 13: Liability-Driven and Index-Based Strategies