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Canada (509,777)
MIS 4500 (31)
Lecture

Chapter 29.docx

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Department
Management Info. Systems
Course
MIS 4500
Professor
Pourang Irani
Semester
Winter

Description
Chapter 29: Relative-Value Methodologies for Global Credit Bond Portfolio Management Credit Relative-Value Analysis  Relative value: ranking of fixed-income investments by sectors, structures, issuers, and issues in terms of their expected performance during some future period of time  classic analysis: top-down and bottom-up analysis  Relative-Value Methodologies: o Total return analysis o primary market analysis o liquidity and trading analysis o secondary trading rationales and constraints analysis o spread analysis o structure analysis o credit curve analysis o credit analysis o asset allocation / sector analysis  Total Return Analysis: optimize risk-adjusted total return; analyze detailed dissection of past returns and project expected returns; uncover patterns (large v. small issue performance variation, seasonality, election-cycle effects, gov’t benchmark auction effects, etc.)  Primary Market Analysis: new issue supply & demand; contrary to normal supply-price relationship, relative credit returns often perform best during periods of heavy supply o effect of market-structure dynamics: adapt portfolio to long-term structure changes in composition of global credit asset class due to desire of issuers to minimize funding costs under different yield curve and yield spread, as well as needs of both active and asset/liability bond managers to satisfy their risk and return objectives o Effect of product structure:  1. dominancy of bullet structures translates into scarcity value for structures w/ embedded call and put features  2. bonds w/ maturities beyond 20 yrs are small share of outstanding credit debt  3. use of credit derivatives has skyrocketed  Liquidity and Trading Analysis: maybe trade potential liquidity disadvantage for incremental yields  Secondary Trade Rationales: o popular reasons for trading:  1. yield/Spread Pickup Trades: say determine rating differential b/w two issues irrelevant and pickup yield difference  2. Credit-Upside Trades: when manager expects upgrade to issuer’s credit quality but not already reflected in yield spread; popular in crossover sector  3. Credit-Defense Trades: in defense of geopolitical and economic uncertainties  4. New Issue Swaps: use swaps to add exposure to a new issuer or a new structure  5. Sector-Rotation Trades:  6. Curve-Adjustment Trades: portfolio duration tilt based on projected changes in credit term structure or credit curve  7. Structure Trades: swaps into structures expected to have better performance given expected movements in volatility and shape of yield curve  8. Cash Flow Reinvestment: take advantage of cash flow reinvestment effect on spreads o Trading constraints:  1. Portfolio constraints: say from IPS or regulatory; say can’t own non- investment grade  2. ―Story‖ Disagreement: action may be limited by uncertainty of one story over another  3. Buy-and-Hold: as a result of accounting constraints  4. Seasonality: say when month ends, or at year-end, when reports etc. made Spread Analysis:  Alternative Spread Measures: o OAS has diminished from reduction in structures w/ embedded option o zero-volatility spread o swap spreads in Europe o credit spread using U.S. agency benchmark curve o credit-default swap spreads  Closer look at swap spreads: many practitioners envision convergence to single global spread standard derived from swap spreads  Spread tools: o 1. mean-reversion analysis o 2. Quality-Spread Analysis: examine spread differentials b/w low- and high- quality credits o 3. Percent Yield Spread Analysis: ratio of credit yields to gov’t yields for similar duration securities; not very predictive Structural Analysis: bullet, callable, putable, sinking fund  bullets o front-end bullets (1 to 5-yr maturities): useful for barbellers; asset swappers may convert short bullets into floating-rate products o intermediate credit bullets (5- to 12 yr maturities): o 30-yr maturity  Callables  Sinking Funds: series of partial calls prior to maturity  Putables: Credit Curve Analysis:  almost always positively sloped  credit barbell strategy: take credit risk in short and intermediate maturities and substitute less-risky gov’t securities in long-duration portfolio buckets  default risk increases non-linearly as credit-worthiness declines Credit Analysis: predict upgrades and downgrades Asset Allocation/Sector Rotation:  ―macro‖ among industrials, utilities, financial institutions, sovereigns, and supranationals  ―micro‖ detailed risk/return breakdown of main credit sub-sectors (banks, brokerage, energy, electrics, media, railroads, sovereigns, supranationals, technology); exhibit on book 4, p. 85 Reading 30: Fixed-Income Portfolio Management—Part II Other Fixed-Income Strategies:  Combination Strategies: active/passive combination; active/immunization combination  Leverage: 1. the larger the amt of borrowed funds, the greater the variation in potential outcomes; 2. the greater the variability in annual return on invested funds, the greater the variation in potential outcomes o portfolio rate of return = R P r F B E  r  k F  D A D L o duration: D E A L E o Repurchase Agreements: K involving sale of securities such as Treasury instruments coupled w/ agmt to repurchase same securities on later date (functions like collateralized loan)  difference b/w selling price and purchase price referred to as ―interest‖  provides low-cost way for managers to borrow funds by providing Treasury securities as collateral  enables investors to earn return above risk-free rate on Treasury securities w/o sacrificing liquidity  transfer of securities: forms:  physical delivery (costly)  transferred simply be credits and debits at clearing agent (still involves fees and charges)  deliver securities to custodial account at seller’s bank (reduces costs)  may not require delivery at all if comfortable  Factors affecting repo rate:  Quality of collateral  Term of repo  Delivery requirement: the greater the repo investor control, the lower the rate  Availability of collateral: the more difficult (in short supply) it is to obtain the securities the lower the rate  Prevailing interest rates in economy: if federal funds rate (unsecured overnight loans of excess reserves) higher, higher rate  seasonal factors  Derivatives-Enabled Strategies: means to create, reduce or magnify factor exposures of an investment o Interest rate risk: n  D iV i i1  portfolio duration is weighted avg: V p  adjustments to portfolio often such to keep duration same, so often D V reference to dollar duration: Dollar duration = i i 100 o Other risk measures:  Semivariance: measures dispersion of return outcomes below target returns  Shortfall risk: probability of not achieving some specified return target  Value at risk (VAR): estimate of loss portfolio manager expects to be exceeded w/ given level of
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