Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session 10 June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2017 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 21: Introduction to Fixed Income Portfolio Management Question ID: 134522 Correct Answer: B Return component Formula Yield income + Rolldown return Annual coupon/current bond price 𝐵𝑜𝑛𝑑 𝑝𝑟𝑖𝑐𝑒+,- − 𝐵𝑜𝑛𝑑 𝑝𝑟𝑖𝑐𝑒/01 𝐵𝑜𝑛𝑑 𝑝𝑟𝑖𝑐𝑒/01 Calculation $3.20/$97.85 = 3.27% ($99.00 – $97.85)/$97.85 = 1.18% = Rolldown yield +E(change in price based on Summers’ yield and yield spread view) +E(currency gains) [−𝑀𝐷 × ∆𝑌𝑖𝑒𝑙𝑑 + ; : × 𝐶𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 × ∆𝑌𝑖𝑒𝑙𝑑< B] < 4.45% [- 2.60 × 1.80] + [1/2 × 1.30 × 1.802] = - 2.574% Given 1.95% =Total expected return 3.826% Question ID: 134523 Correct Answer: B B is correct Summers is using the enhanced indexing approach to manage Topa as her objective is to earn an active return of 25 bps, a modest return objective Furthermore, the portfolio weights deviate slightly from the benchmark index while duration is nearly matched to that of the index Question ID: 134524 Correct Answer: B B is correct All $ figures are in millions To determine the impact of leverage on fund returns, total portfolio returns will need to be calculated as follows: rP = rI + VB (rI - rB ) = 0.078 + $15 (0.078 - 0.063) = 0.087 VE $25 Topa’s returns will increase from 7.80% to 8.70% FinQuiz.com © 2017 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com Question ID: 134525 Correct Answer: B B is correct Unlike fixed-coupon bonds, floating-coupon bonds not generate a pre-determined cash flow stream which is known at the time the bond is issued On each reset date, the reference rate is reset to the inflation rate prevailing in the market Therefore, the coupon rate is not known in advance A is incorrect Floating-coupon bonds have a low (and negative) correlation with the rest of the portfolio and thus their addition to Topa will generate diversification benefits by reducing the overall risk of the fund C is incorrect Floating-coupon bonds provide a hedge against inflation because the reference rate should adjust for inflation Question ID: 134526 Correct Answer: B B is correct Given that fund investors are taxable, Summers should seek to minimize taxes when liquidating corporate bonds by deferring capital gains and realizing capital losses early to offset current or future capital gains Summers should therefore seek to liquidate Issue B because of its embedded capital loss which will result in a lower net realized capital gain being distributed to investors Question ID: 134527 Correct Answer: A A is correct Statement is correct Duration matching seeks to match the duration of the assets portfolio with the liabilities portfolio as well as the present value of both these portfolios The idea is that changes in the bond portfolio’s market value closely match the change in the liability portfolio and any shortfall in cash flows is covered by the asset portfolio B is incorrect Statement is incorrect In general, immunization approaches can accommodate bonds with embedded options to the extent that a bond’s duration is replaced by its effective duration FinQuiz.com © 2017 - All rights reserved .. .Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz. com FinQuiz Level III 2018 – Item- sets Solution Reading 21: Introduction to Fixed Income... (0.078 - 0.0 63) = 0.087 VE $25 Topa’s returns will increase from 7.80% to 8.70% FinQuiz. com © 2017 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz. com... 134 527 Correct Answer: A A is correct Statement is correct Duration matching seeks to match the duration of the assets portfolio with the liabilities portfolio as well as the present value of