Carol Harrod is the investment officer for a $100 million U.S. pension fund. The fixed-income portion of the portfolio is actively managed, and a substantial portion of the fund’s large capitalization U.S. equity portfolio is indexed and managed by Webb Street Advisors.

Harrod has been impressed with the investment results of Webb Street’s equity index strategy and is considering asking Webb Street to index a portion of the actively managed fixedincome portfolio.

a. Describe the advantages and disadvantages of bond indexing relative to active bond management.

b. Webb Street manages indexed bond portfolios. Discuss how an indexed bond portfolio is constructed under stratified sampling (cellular) methods.

c. Describe the main source of tracking error for the cellular method. P-963