Fixed-income portfolios

See Moorad Choudhry, Issues in the Asset Swap Pricing of Credit Default Swaps, in Frank J. Fabozzi (editor), Professional Perspectives on Fixed Income Portfolio Management Volume 4 (Hoboken, NJ John Wiley Sons, Inc., 2003). 

Maturities are 1 to 6 months, 9 months, 1 to 12, and 15, 18, 20, 22, 25, 27, and 30 years. For more details, see Lionel Martellini, Phillippe Priaulet, and Stephane Pri-aulet, The Euro Benchmark Yield Curve Principal Component Analysis of Yield Curve Dynamics, in Frank J. Fabozzi (ed.), Professional Perspectives on Fixed Income Portfolio Management Volume 4 (Hoboken, NJ John Wiley Sons, Inc., 2003). 

Unlike bonds, equities do not mature. Equity portfolios and their benchmarks have the same expected duration (i.e., that of a perpetual security) at the end of a certain period as they did at the beginning. The duration of a fixed-income portfolio comes down over time through a process known as duration drift, which does not occur in equities. Duration drift is an important consideration when looking at a portfolio over a 1-year horizon given that returns are predominantly duration-driven in fixed income markets. 

For fixed-income portfolios, this method theoretically represents an improvement because it takes into account all the factors affecting bond prices (and could also include pull-to-par) and it is a very powerful method for calculating VaR. 

The introduction of an index approach to portfotio management has marked a fundamental shift in the way fixed income portfolios are managed in Europe. Increasingly, fund managers and, more importantly, chief investment officers are looking to measure the performance of portfolios and portfolio managers in an objective fashion. We believe that the best way to approach the problem is to adopt a beat the benchmark approach. 

In order to answer the question what share should be taken up by corporate bonds in a portfolio, ex post simulations were run. The Markowitz approach of portfolio optimization is based on using expected returns. Since the question of determining the optimal fixed income portfolio is to be answered against the background of historical data, the return and variance/covariance estimators are replaced by their historical return means and variances/covariances respectively. These historical data are computed congruently to the relevant investment horizon. For a 3-year investment horizon, the return means and variances/covariances of assets are computed on the basis of 36 monthly returns. The same is, in analogy, done for a 5-year investment horizon on the basis of 60 monthly returns. Investment horizons of three, five, and 10 years are analyzed here. For the investment horizon of, for example, five years, the monthly data in the time window from February 1980 to January 1985 are used. 

A noteworthy fact is that fixed-income portfolios in times of economic prosperity in the United States, like at the beginning and mid-1980s, achieved impressive results. Note that all return figures displayed in this chapter are nominal values and apply for the US dollar area. In particular the beginning 1980s were characterized by high inflation rates and nominal yields. In the course of the 1990s, inflation and nominal rates dropped. 

In this chapter we addressed the question of what proportions corporate and government bonds of different credit quality and maturity segments an investor should hold in a fixed-income portfolio. Maximizing the risk/ return relation according to the Markowitz approach is the core issue here. Optimal portfolio weights were established in ex post simulations. 

Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited by Frank J. Fabozzi... 

Measuring and Controlling Interest Rate and Credit Risk Second Edition by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry Professional Perspectives on Fixed Income Portfolio Management, Volume 4 edited by Frank J. Fabozzi... 

Active fund management involves just that the manager makes the decision on which bonds to buy and the time at which to buy (and subsequently sell) them. The performance of an actively managed fixed-income portfolio is still measured against the relevant benchmark or index, because this serves to illustrate how well the manager is doing. If... 

Laddering refers to creating a structure of varied maturities. You construct your fixed-income portfolio by staggering the maturity dates, so the principal will return to you at different, albeit ex-... 

On the surface, MV analysis is not especially difficult to implement. For example, it is very easy to guess at future stock and bond returns and use historical variances and correlations to produce an optimum portfolio. It is not so simple to create a multidimensional portfolio consisting of multiple equity and fixed income instruments combined with tiltemative assets such as private equity, venture capital, hedge ftmds, and other wonders. Sophisticated applications require a lot of groundwork, creativity, and rigor. 

Note that the unspanned stochastic volatility models are contradictory to the stochastic volatility models of Fong and Vasicek [31], Longstaff and Schwartz [56] and de Jong and Santa-Clara [24], where the bond market is complete and all fixed-income derivatives can be hedged by a portfolio solely... 

In this thesis we derived new methods for the pricing of fixed income derivatives, especially for zero-coupon bond options (caps/floor) and coupon bond options (swaptions). These options are the most widely traded interest rate derivatives. In general caps/floors can be seen as a portfolio of zero-coupon bond options, whereas a swaption effectively equals an option on a coupon bond (see chapter (2)). The market of these LIBOR-based interest rate derivatives is tremendous (more than 10 trillion USD in notional value) and therefore accurate and efficient pricing methods are of enormous practical importance. 

Fong H, Vasicek O (1991) Fixed Income Volatihty Management. The Journal of Portfolio Management (Summer), 41-46. 

A fundamental property is that an upward change in a bond s price results in a downward move in the yield and vice versa. This result makes sense because the bond s price is the present value of the expected future cash flows. As the required yield decreases, the present value of the bond s cash flows will increase. The price/yield relationship for an option-free bond is depicted in Exhibit 1.9. This inverse relationship embodies the major risk faced by investors in fixed-income securities—interest rate risk. Interest rate risk is the possibility that the value of a bond or bond portfolio will decline due to an adverse movement in interest rates. 

The source of dollar return called reinvestment income represents the interest earned from reinvesting the bond s interim cash flows (interest and/or principal payments) until the bond is removed from the investor s portfolio. With the exception of zero-coupon bonds, fixed income securities deliver coupon payments that can be reinvested. Moreover, amortizing securities (e.g., mortgage-backed and asset-backed securities) make periodic principal repayments which can also be invested. 

Institutional investors such as pension funds and insurance companies often prefer to enhance the income from their fixed interest portfolios by... 

It is a fact that bond yields and bond prices possess predictable behaviour patterns. Several well-documented rules have been established that can assist a fixed income security analyst/portfolio manager in deciding which bonds to hold in a portfolio given a future potential interest rate scenario and the goal of the portfolio. 

Swaptions are options that allow the buyer to obtain at a future time one position in a swap contract. It is quite elementary that an interest rate swap, fixed for floating, can be understood as a portfolio of bonds.To consider this assume that the notional principal is 1. Then the claim on the fixed payments is the same as a bond paying coupons with the rate p and no principal. Let X be the time when the swap is conceived. The claim on the fixed income stream is worth, at time X,... 

Fixed Income Risk Modeling for Portfolio Managers... 

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