CFA level 3 CFA level 3 volume III applications of economic analysis and asset allocation finquiz item set questions, study session 12, reading 21

Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com FinQuiz.com CFA Level III Item-set - Question 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 © 2018 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com FinQuiz Item-set ID: 134521 Questions 1(134522) through 6(134527) relate to Reading 21 Tina Summers Case Scenario Tina Summers is the fund manager for Topa, a global fund comprising domestic and foreign bonds The benchmark for the fund is a global bond index Summers manages the fund with the objective of earning a periodic return of at least 25 basis points in excess of the benchmark The fund’s investors are taxable institutions As a starting point, Summers computes the 12-month expected return for Topa using data collected in Exhibit The data incorporates income earned on the reinvestment of coupons Exhibit Notional value of fund’s investments Average annual coupon Current average bond price Expected average bond price (in 12 months) Modified duration Modified convexity Expected currency gains Expected average yield and yield spread change $25 million $3.20 $97.85 $99.00 2.60 1.30 1.95% 1.80% Next, Summers compares the composition and weighted average duration of Topa relative to its benchmark index for the purposes of performance evaluation Exhibit summarizes the results of her analysis Exhibit Securities Treasuries Corporate bonds Floating-coupon bonds Emerging market bonds Domestic high-yield bonds Total Duration Fund Benchmark Index 25% 30 15 22 100 2.60 28% 32 10 27 100 2.58 Topa is currently unleveraged and Summers is contemplating leveraging the fund to further increase returns Exhibit summarizes a proposed leveraging strategy FinQuiz.com © 2018 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com Exhibit Amount borrowed Current value of Topa’s equity Return on invested funds Cost of borrowing $15 million $25 million 7.80% 6.30% Summers attempts to explain the over allocation in floating-coupon bonds relative to the benchmark index noting that the asset class has a duration of – and a correlation of – 0.30 with the rest of the portfolio A year later Summers decides to reduce Topa’s corporate bond holdings and invest the proceeds in emerging market bonds which have a higher expected return Summers is comparing two bond issues in the fund for potential liquidation (Exhibit 4) Exhibit Current market value Capital gains/losses Coupon rate Investment view Time to maturity Income tax rate Capital gains tax rate Issue A $850,000 $42,000 5.00% Overvalued years Issue B $850,000 - $42,000 5.00% Undervalued years 40% 37% The Bascille Corporation’s pension fund’s portfolio is partially invested in Topa The plan’s chief investment officer (CIO) holds a meeting with Summers to discuss his plans for implementing an immunization approach with an emphasis on duration matching for the policy portfolio He shares his understanding of the approach with Summers as follows: Statement 1: “Duration-matching seeks to minimize cash flow shortfall risk by matching the duration and present value of the liability stream.” Statement 2: “Duration-matching approach cannot accommodate bonds with embedded options, so we will need to liquidate Bascille’s portfolio holdings of any such bonds.” FinQuiz Question ID: 134522 Using the data in Exhibit 1, the fund’s expected return is closest to: A 3.79% B 3.83% C 13.19% FinQuiz.com © 2018 - All rights reserved Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz.com FinQuiz Question ID: 134523 Using the data in Exhibit 2, which investment mandate has Summers employed for managing Topa? A Pure indexing B Enhanced indexing C Active management FinQuiz Question ID: 134524 Using the data in Exhibit 3, will the use of leverage increase Topa’s returns? A No B Yes, Topa’s return will increase to 8.70% C Yes, Topa’s return will increase to 10.30% FinQuiz Question ID: 134525 Which of the following reasons least likely supports the over allocation of the Topa fund to floating-coupon bonds? A Diversification of risk B Stabilize cash flow stream C Inflation hedging potential FinQuiz Question ID: 134526 Considering the fund investors, which issue should Summers consider for liquidation? A Issue B Issue C Neither of the two issues; the liquidation of issues will trigger capital gains taxes which should be avoided FinQuiz Question ID: 134527 Considering the CIO’s discussion concerning duration-matching, he is most likely correct regarding: A Statement only B Statement only C both of the statements FinQuiz.com © 2018 - All rights reserved  .. .Reading 21 Introduction to Fixed Income Portfolio Management FinQuiz. com FinQuiz Item- set ID: 134 521 Questions 1( 134 522) through 6( 134 527) relate to Reading 21 Tina Summers Case... holdings of any such bonds.” FinQuiz Question ID: 134 522 Using the data in Exhibit 1, the fund’s expected return is closest to: A 3. 79% B 3. 83% C 13. 19% FinQuiz. com © 2018 - All rights reserved Reading. .. increase to 10 .30 % FinQuiz Question ID: 134 525 Which of the following reasons least likely supports the over allocation of the Topa fund to floating-coupon bonds? A Diversification of risk B Stabilize