BWFN3053: FIXED INCOME SECURITIES

SEMESTER A211
Group Assignment 2: Problem Solving
Total Marks: 100 (20 Q * 5 Marks)

Instruction: Submit (type only, no handwritten) in word file and upload online portal by one
member from each group.

Topic 9 (Chapter 25)

1. Smith & Jones is a money management firm specializing in fixed-income securities. One of
its clients gave the firm $100 million to manage. The market value for the portfolio for the four
months after receiving the funds was as follows:
End of Month Market Value (in millions)
1 $ 50
2 $150
3 $ 75
4 $100

Answer the below questions based on the above table.

(a) Calculate the rate of return for each month.
(b) Smith & Jones reported to the client that over the four-month period the average monthly
rate of return was 33.33%. How was that value obtained?
(c) Is the average monthly rate of return of 33.33% indicative of the performance of Smith &
Jones? If not, what would be a more appropriate measure?

2. The Mercury Company is a fixed-income management firm that manages the funds of
pension plan sponsors. For one of its clients it manages $200 million. The cash flow for this
particular client’s portfolio for the past three months was $20 million, −$8 million, and
$4 million. The market value of the portfolio at the end of three months was $208 million.

Answer the below questions.

(a) What is the dollar-weighted rate of return for this client’s portfolio over the three-month
period?
(b) Suppose that the $8 million cash outflow in the second month was a result of withdrawals by
the plan sponsor and that the cash flow after adjusting for this withdrawal is therefore zero. What
would the dollar-weighted rate of return then be for this client’s portfolio?

1
3. A financial institution has hired three external portfolio managers: X, Y, and Z. All three
managers have the same benchmark. A performance attribution analysis of the portfolios
managed by the three managers for the past year was (in basis points):

Risk Factor Portfolio X Portfolio Y Portfolio Z

Yield curve risk –1 92 –3
Swap spread risk 20 4 20
Volatility risk 40 3 25
Government related spread risk 35 –5 10
Corporate spread risk –2 6 30
Securitized spread risk –2 –4 5

The financial institution’s investment committee is using the above information to assess the
performance of the three external managers. Below is a statement from three members of the
performance evaluation committee. Respond to each statement.
(a) Committee member 1: “Based on overall performance, it is clear that manager Y was the
best performing manager given the 96 basis points.”
(b) Committee member 2: “All three of the managers were hired because they claimed that
they had the ability to capitalize on corporate credit opportunities. Although they have all
outperformed the benchmark, I am concerned about the claims that they made when we
retained them.”
(c) Committee member 3: “It seems that managers X and Z were able to outperform the
benchmark without taking on any interest rate risk at all.”

4. If the average quarterly return for a portfolio is 1.78%, what is the annualized return?

Topic 10 (Chapter 26)

5. Suppose that bond ABC is the underlying asset for a futures contract with settlement six
months from now. You know the following about bond ABC and the futures contract: (1) In
the cash market ABC is selling for $80 (par value is $100); (2) ABC pays $8 in coupon interest
per year in two semiannual payments of $4, and the next semiannual payment is due exactly
six months from now; and (3) the current six-month interest rate at which funds can be loaned
or borrowed is 6%.

Answer the below questions.

(a) What is the theoretical futures price?
(b) What action would you take if the futures price is $83?

2
(c) What action would you take if the futures price is $76?
(d) Suppose that bond ABC pays interest quarterly instead of semiannually. If you know that
you can reinvest any funds you receive three months from now at 1% for three months, what
would the theoretical futures price for six-month settlement be?
(e) Suppose that the borrowing rate and lending rate are not equal. Instead, suppose that the
current six-month borrowing rate is 8% and the six-month lending rate is 6%. What is the
boundary for the theoretical futures price?

6. Suppose that without an adjustment for the relationship between the yield on a bond to be
hedged and the yield on the hedging instrument the hedge ratio is 1.30.

Answer the below questions.

(a) Suppose that a yield beta of 0.8 is computed. What would the revised hedge ratio be?
(b) Suppose that the standard deviation for the bond to be hedged and the hedging instrument
are 0.09 and 0.10, respectively. What is the pure volatility adjustment, and what would be the
revised hedge ratio?

7. Consider the portfolio in Exhibit 26-3. Suppose that the dollar duration of the 5-year
Treasury note futures contract is $5,022.

Answer the below questions.

(a) What position would a portfolio manager have to take in the contract to hedge the portfolio?
(b) What is the market value of the position that the portfolio manager must take?
(c) What position would a portfolio manager have to take in the contract to obtain a portfolio of
4?
(d) What is the market value of the position that the portfolio manager must take?

3
4
5
6