4. You manage a highly leveraged portfolio of fixed income securiites on behalf of high-net-worth clients. This portfolio has the following allocations: government bonds (40%), corporate bonds (20%), mortgage-backed securiites (25%), and high yield bonds (15%). The portfolio is levered 20-to1, meaning you control $2,000 of securities for every $100 clients have entrusted with you. Your prime broker finances these positions subject to the following haircuts (i.e., discounts to the current value of the bonds, meaning you are required to finance the remainder with the Funds equity, which is the money from clients):

Government Bonds: 1%

Corporate Bonds: 2%

Mortgage-Backed Securities: 1.5%

High Yield Bonds: 5%

a) If clients provided you with $100 million to manage in this fashion, what is the amount of the portfolios equity required to support these positions?

b) Now assume markets become unstable and your lender begins to panic. They quickly triple all of the haircut percentages listed in part a) above. Assuming you wanted to keep the same allocations, by how much would you have to shrink your portfolio and still have at least $10 million in unencumbered equity (i.e., money that is not required to support your positions)? List the new portfolio allocations in dollars that would remain after this shrinkage.

c) As these haircuts are widening, also assume bid/ask spreads are widening as well. In fact, the bid/ask spread for high yield bonds has widened from .5% of the par amount of the bond to 2.5%, whereas the bid/ask spread has only widened from .01% of par to .02%. The spread widening for corporate bonds and mortgage-backed securities lies somewhere between these two extremes. Assuming you decide not to stick to your target asset allocations, which securities are you likely to try to sell to reduce the portfolios equity requirements? Briefly explain your answer.