Question

A member of a firm’s investment committee is very interested in learning about the management of fixed-income portfolios. He would like to know how fixed-income managers position portfolios to capitalize on their expectations concerning three factors influencing interest rates. Assuming that no investment policy limitations apply, formulate and describe a fixed-income portfolio management strategy for each of the following interest rate factors that could be used to exploit a portfolio manager’s expectations about that factor.

( Note: Three strategies are required, one for each listed factor.)

a. Changes in the level of interest rates.

b. Changes in yield spreads across/between sectors.

c. Changes in yield spreads as to a particular instrument.

Short answer

Answer

a. Rate anticipation swap

b. Inter-market spread swap

c. Substitution swap

Step-by-step solution

Step by Step Solution Step 1: Explanation of the choice of fixed income portfolio management strategy ‘a’.

Rate anticipation swap will lengthen the duration if rates are expected to fall and shorten if rates are expected to rise.

Explanation of the choice of fixed income portfolio management strategy ‘b’

Inter-market spread swap because this manager can buy the bond in the sector in which yields are expected to fall and sell bonds where results are expected to rise.

Explanation of the choice of fixed income portfolio management strategy ‘c’

Substitution swap, Because in this the security would be sold if its relative yield is expected to rise, or is bought if its work is expected to fall compared to other similar bonds.