QUESTION SEVEN a). Discuss rate anticipation swaps as a bond portfolio managemen
ID: 2789367 • Letter: Q
Question
QUESTION SEVEN
a). Discuss rate anticipation swaps as a bond portfolio management strategy. (10 Marks)
b) You manage a portfolio for Ms. Greenspan, who has instructed you to be sure her portfolio has a value of at least $350,000 at the end of six years. The current value of Ms. Greenspan's portfolio is $250,000. You can invest the money at a current interest rate of 8%. You have decided to use a contingent immunization strategy.
i). What amount would need to be invested today to achieve the goal, given the current interest rate? (6 marks)
ii). Suppose that four years have passed and the interest rate is 9%. What is the trigger point for Angel's portfolio at this time? (That is, how low can the value of the portfolio be before you will be forced to immunize to be assured of achieving the minimum acceptable return? (6 marks)
iii) If the portfolio's value after 4 years is $291,437 what should you do? (4 marks)
c). In an increasingly globalized investment environment, comparability problems become even greater. Discuss some of the problems for the investor who wishes to have an internationally diversified portfolio. (10 marks)
Explanation / Answer
a) As name suggests "Rate Anticipation Swap" is very commonly used by portfolio manager to take advantage of anticipating changing interest rate scenario in future. When a portfolio manager feels that existing bond yield is not good enough and there are other bond(s) available with different maturity, they sell this bond and buy a new bond for better yield.
Sometime, portfolio manager deals with short-term bonds over long-term bonds if there is a possibility of interest rate fall and again they prefer long duration bond when the future interest rate expected to rise. Therefore, the strategy of purchase of one bond simultaneously with the sale of another bond of different maturity in order to take maximum advantage of expected changes in interest rates is known as "Rate Anticipation Swap"
b) i)
In "contingent immunization strategy" the portfolio manager prefers to invest in low or no risk kind of investment to make sure return is guaranteed. This will help to portfolio manager to minimize loss as much as possible with defined returned.
Since, Ms. Greenspan needs $350,000 in 6 years from now, the portfolio manager needs to invest in certificate of deposit with 8% of current interest rate. The Present Value (PV) of $350,000 from now would be
PV = 350,000/1.08^6 = $220,559
Out of $250,000 the portfolio manager will need to invest $220,559 to get desired portfolio value of $350,000.
b)ii) Since the interest rate has gone up to 9% then portfolio manager continue to invest in CDs for return more than expected of $350,000.
b) iii) The end of year 4 the return is $291,437 that means with 9% interest rate for rest of 2 years the final portfolio value would be $346,256 using FV = PV*1.09^2 formula.
Initially portfolio manager invested $214,214 from $250,000 portfolio. At the end of year 4 he needs to add $3,150 amount to $291,437 to become $294,587. 294,587*1.09^2 = $350,000.