Question 2 (20%) (A) An investor has the following bond portfolio: Semi Annual Coupon Face Value (pa) Bond A US$2,000,000 10 Bond B US$4,500,000 3 Bond C US$3,500,000 6.5 Bond D US$7,000,000 0 US$17,000,000 Maturity (Yrs) 6 5 1 12 Semi Annual Yield (pa) 7.4 6.6 8 5 (1) What is the portfolio Macaulay duration? (4 Marks) (ii) The interest rate outlook expects to increase so the investor decides to reduce the portfolio to a target Macaulay duration of 3. The investor decides to keep the weighting on Bond C and Bond A, how much Bond B and Bond D do the investor need to change in order to meet the target? (7 Marks) (iii) Instead of (ii), the investor has a choice to keep all the bond portfolio and only to replace Bond A by one of the following three bonds issued by the same issuer to decrease portfolio duration. Annual Credit Semi Annual Coupon Maturity Semi Annual Yield Maculary Rating (%opa) (Yrs) (%opa) Duration Bond X AA 10 4.5 3 Bond Y AAA 10 6 3 Bond z CCC 10 6 4.5 3 6 4.5 Explain which of these 3 bonds will the investor choose to have the best protective impact on interest rate increase? (3 Marks) (B) The diagram below shows the impact of Credit Ratings on Bond Yields Spread BBB Treasuries over A AA AAA Maturity A bond investor has a portfolio of AA, A, BBB and BB corporate bonds from the same sector. The investor expects a declining yield spread between AA and A rating, while a widening yield between AA and BB rating, though the yields for A rated bonds remain constant. In anticipation of such move, the investor will adjust the weighting of these bonds. Which would he "overweight, underweight and neutral based the expectation? (6 Marks) Question 2 (20%) (A) An investor has the following bond portfolio: Semi Annual Coupon Face Value (pa) Bond A US$2,000,000 10 Bond B US$4,500,000 3 Bond C US$3,500,000 6.5 Bond D US$7,000,000 0 US$17,000,000 Maturity (Yrs) 6 5 1 12 Semi Annual Yield (pa) 7.4 6.6 8 5 (1) What is the portfolio Macaulay duration? (4 Marks) (ii) The interest rate outlook expects to increase so the investor decides to reduce the portfolio to a target Macaulay duration of 3. The investor decides to keep the weighting on Bond C and Bond A, how much Bond B and Bond D do the investor need to change in order to meet the target? (7 Marks) (iii) Instead of (ii), the investor has a choice to keep all the bond portfolio and only to replace Bond A by one of the following three bonds issued by the same issuer to decrease portfolio duration. Annual Credit Semi Annual Coupon Maturity Semi Annual Yield Maculary Rating (%opa) (Yrs) (%opa) Duration Bond X AA 10 4.5 3 Bond Y AAA 10 6 3 Bond z CCC 10 6 4.5 3 6 4.5 Explain which of these 3 bonds will the investor choose to have the best protective impact on interest rate increase? (3 Marks) (B) The diagram below shows the impact of Credit Ratings on Bond Yields Spread BBB Treasuries over A AA AAA Maturity A bond investor has a portfolio of AA, A, BBB and BB corporate bonds from the same sector. The investor expects a declining yield spread between AA and A rating, while a widening yield between AA and BB rating, though the yields for A rated bonds remain constant. In anticipation of such move, the investor will adjust the weighting of these bonds. Which would he "overweight, underweight and neutral based the expectation? (6 Marks)
