Investment Analysis and Portfolio Management: Frank K. Reilly & Keith C. Brown

Lecture Presentation Software
to accompany
Investment Analysis and

Portfolio Management
Seventh Edition
by
Frank K. Reilly & Keith C. Brown
Chapter 20
Chapter 20 - Bond
Portfolio Management Strategies
Questions to be answered:
What are the four major bond portfolio
management strategies?
What are the two specific passive
portfolio management strategies
available?
Chapter 20 - Bond
What are the five alternative strategies
available within the active management
category?
What is meant by care-plus bond management
and what are some plus strategies?
What is meant by matched-funding techniques,
and what are the four specific strategies
available in this category?
Chapter 20 - Bond
What are the major contingent
procedure strategies that are also
referred to as structured active
management strategies?
What are the implications of capital
market theory for those involved in bond
portfolio management?
Chapter 20 - Bond
What is the evidence on the efficient
market hypothesis as it relates to bond
markets?
What are the implications of efficient
market studies for bond portfolio
managers?
Alternative Bond Portfolio Strategies

1. Passive portfolio strategies
2. Active management strategies
3. Matched-funding techniques
4. Contingent procedure (structured active
management)
Passive Portfolio Strategies

Buy and hold
A manager selects a portfolio of bonds based on
the objectives and constraints of the client with
the intent of holding these bonds to maturity
Indexing
The objective is to construct a portfolio of
bonds that will equal the performance of a
specified bond index
Active Management Strategies

Interest-rate anticipation
Risky strategy relying on uncertain forecasts
Ladder strategy staggers maturities
Barbell strategy splits funds between short
duration and long duration securities
Valuation analysis
The portfolio manager attempts to select bonds
based on their intrinsic value
Credit analysis
Involves detailed analysis of the bond issuer to
determine expected changes in its default risk
Active Management Strategies

Yield spread analysis
Assumes normal relationships exist between the
yields for bonds in alternative sectors
Bond swaps
Involve liquidating a current position and
simultaneously buying a different issue in its
place with similar attributes but having a chance
for improved return
Bond Swaps
Pure Yield Pickup Swap
Substitution Swap
Tax Swap
Swap strategies and market-efficiency

Bond swaps by their nature suggest
market inefficiency
A Global Fixed-Income
Investment Strategy
Factors to consider
The local economy in each country including
the effects of domestic and international
demand
The impact of total demand and domestic
monetary policy on inflation and interest
rates
The effect of the economy, inflation, and
interest rates on the exchange rates among
countries
Core-Plus Bond Portfolio

Management
This involves having a significant (core) part of
the portfolio managed passively in a widely
recognized sector such as the U.S. Aggregate
Sector or the U.S. Government/Corporate sector.
The rest of the portfolio would be managed
actively in one or several additional plus sectors,
where it is felt that there is a higher probability of
achieving positive abnormal rates of return
because of potential inefficiencies
Matched-Funding Techniques
Dedicated Portfolios
Dedication refers to bond portfolio
management techniques that are used to
service a prescribed set of liabilities
Pure CashMatched Dedicated Portfolios
Most conservative strategy
Dedication With Reinvestment
Cash flows do not have to exactly match
the liability stream
Immunization Strategies
A portfolio manager (after client consultation)
may decide that the optimal strategy is to
immunize the portfolio from interest rate
changes
The immunization techniques attempt to derive
a specified rate of return during a given
investment horizon regardless of what happens
to market interest rates
Immunization Strategies
Components of Interest Rate Risk
Price Risk
Coupon Reinvestment Risk
Classical Immunization
Immunization is neither a simple nor a
passive strategy
An immunized portfolio requires
frequent rebalancing because the
modified duration of the portfolio
always should be equal to the
remaining time horizon (except in the
case of the zero-coupon bond)
Classical Immunization
Duration characteristics
Duration declines more slowly than term to
maturity, assuming no change in market interest
rates
Duration changes with a change in market interest
rates
There is not always a parallel shift of the yield
curve
Bonds with a specific duration may not be
available at an acceptable price
Horizon matching
Combination of cash-matching dedication and
immunization
Important decision is the length of the horizon
period
Contingent Procedures
A form of structured active management
Constrains the manager if unsuccessful
Contingent immunization
duration of portfolio must be maintained at the
horizon value
cushion spread is potential return below current
market
safety margin
trigger point
Implications of Capital Market Theory and

the EMH on Bond Portfolio Management
Bonds and Total Portfolio Theory
Bonds and Capital Market Theory
Bond Price Behavior in a CAPM
Framework
Bond-Market Efficiency
The Internet
Investments Online
www.ryanlabs.com
www.bondbasics.com
www.cms-info.com
www.cboe.com/education/strategy/interestrate.htm
www.finpipe.com
www.prusec.com/ladder.htm
www.deanwitter.com/tfi/milp.html
End of Chapter 20
Bond Portfolio Management
Strategies
Future topics
Chapter 21
An Introduction to Derivative Markets and
Securities

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Investment Analysis and Portfolio Management: Frank K. Reilly & Keith C. Brown

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Lecture Presentation Software

Investment Analysis and

Frank K. Reilly & Keith C. Brown

Alternative Bond Portfolio Strategies

Passive Portfolio Strategies

Active Management Strategies

Active Management Strategies

Swap strategies and market-efficiency

Core-Plus Bond Portfolio

Implications of Capital Market Theory and

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