Question 4 (20 marks) (A) HSU Insurance is hiring a financial consultant to advise them on portfolio immunization strategy. Critique each of the following statements that were made during his presentations: (i) Statement 1. A great thing about immunization is that it is a set-and-forget strategy. That is, once you have immunized your portfolio, there is no subsequent work to be done. (3 marks) (ii) Statement 2. If a portfolio is immunized against a change in the market yield at a given horizon by matching portfolio duration to horizon, the portfolio faces no risk except for default risk. (3 marks) (iii) Statement 3. The liquidity of bonds used to construct an immunized portfolio is irrelevant (i.e. not a factor). (3 marks) (iv) Statement 4. In general, the entire portfolio does not have to be turned over to rebalance an immunized portfolio. (v) Following statement 4 above, to keep a portfolio immunized, rebalancing need not be done on a daily basis. (3 marks) (B) Answer the each of the following questions (i) to (v) about selecting bonds to maximize the return for your client portfolios in terms of each of the following characteristics: - Duration - Coupon - Maturity - Credit rating (i) What would you look for in a bond chosen for your client who can take high risk? (2 Marks) (ii) What would you look for in a bond chosen for your client who can only take low risk? (2 Marks) (iii) If you believe that interest rates will decline sharply in the future, what bond characteristics would you search for? (2 Marks) (iv) If you believe that interest rates will rise sharply in the future, what bond characteristics would you search for? (2 Marks) Question 4 (20 marks) (A) HSU Insurance is hiring a financial consultant to advise them on portfolio immunization strategy. Critique each of the following statements that were made during his presentations: (i) Statement 1. A great thing about immunization is that it is a set-and-forget strategy. That is, once you have immunized your portfolio, there is no subsequent work to be done. (3 marks) (ii) Statement 2. If a portfolio is immunized against a change in the market yield at a given horizon by matching portfolio duration to horizon, the portfolio faces no risk except for default risk. (3 marks) (iii) Statement 3. The liquidity of bonds used to construct an immunized portfolio is irrelevant (i.e. not a factor). (3 marks) (iv) Statement 4. In general, the entire portfolio does not have to be turned over to rebalance an immunized portfolio. (v) Following statement 4 above, to keep a portfolio immunized, rebalancing need not be done on a daily basis. (3 marks) (B) Answer the each of the following questions (i) to (v) about selecting bonds to maximize the return for your client portfolios in terms of each of the following characteristics: - Duration - Coupon - Maturity - Credit rating (i) What would you look for in a bond chosen for your client who can take high risk? (2 Marks) (ii) What would you look for in a bond chosen for your client who can only take low risk? (2 Marks) (iii) If you believe that interest rates will decline sharply in the future, what bond characteristics would you search for? (2 Marks) (iv) If you believe that interest rates will rise sharply in the future, what bond characteristics would you search for? (2 Marks)
