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Hedging bond portfolios

Hedging bond portfolios. CLS Winter Conference 2014. Historical yields. Measures taken to mitigate duration risk. Hedges utilising simple derivative strategies. Short gilts 6 year bank issued note 1, 2 or 3 times short 7-10 year gilts at maturity Rolling of gilts to maintain duration

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Hedging bond portfolios

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  1. Hedging bond portfolios CLS Winter Conference 2014

  2. Historical yields

  3. Measures taken to mitigate duration risk

  4. Hedges utilising simple derivative strategies • Short gilts • 6 year bank issued note • 1, 2 or 3 times short 7-10 year gilts at maturity • Rolling of gilts to maintain duration • Additional floating coupon of 3 month libor +…. Assuming a gradual increase in yields over the next six years Structure implicitly floored if you assume rates can’t go below zero

  5. Fixed rate bonds into floating Day 1 • Investor sells existing portfolio of fixed coupon bonds. • Investor buys a floating rate note with the cash proceeds. During the life • Cash flows arising from the Collateral are passed to the Bank Counterparty. • In return, the Bank Counterparty will pay a libor linked coupon. At maturity • Investor receives 100 less any default amounts on collateral Investor 3 Month Libor + /- Principal at maturity Cash Collateralised Note Platform Fixed Coupons 3 Month Libor + /- Collateral Bank Counterparty Investor effectively creating floating rate notes, whilst maintaining the credit profile of their original portfolio.

  6. Fixed rate bonds into floating

  7. Hedges utilising simple derivative strategies Digital Options Coupon Paid Are current rates above the option strike level? Yes Yes Are we at maturity of the option? No Coupon Option traded in secondary at MTM No No 2.5 pence premium buys you

  8. Hedges utilising simple derivative strategies • Digital Option • 5 years • GBP • Strike 6% • Coupon 16.5% • 2.5% Premium

  9. Hedges utilising simple derivative strategies Payer Swaptions • Provides the holder with the right to enter into a fixed versus float swap Pay a fixed rate Fixed versus float swaps Party A Party B Receive a float rate • At inception the value of the swap is zero, since PV of float leg equal to that of fixed leg. • If rates go up, the mark-to-market of the swap will go in favour of Party A and vice versa.

  10. Hedges utilising simple derivative strategies Payer Swaptions • 6 month duration • Option to enter into 10 year fixed versus float swap • Cash settled, based upon market value of the fixed v float swap at expiry of the option Swap value Are current rates above the option strike level? Yes Yes Are we at maturity of the option? No Payment Option traded in secondary at MTM No No

  11. Hedges utilising simple derivative strategies Payer Swaptions • 6 month duration • Strike  ATMF + 100bps

  12. Hedges utilising simple derivative strategies • Digital Option • 6 months • GBP • 7th July 14 – 7th July 24 fixed v float • 35bps premium

  13. Alternative ways to play rates • Equity linked digital • 6 years • GBP • S&P / FTSE • EKI Put  60% • Digital Barrier  60% • Coupon Payment  Semi-annual • Digital Coupon • Both underlyings at or above Digital Barrier • 226% * GBP 6-month Libor p.a. • Equity linked reverse convertible • 10 years • GBP • S&P / FTSE • EKI Put  60% • Payment at maturity • Both underlyings at or above put barrier • 100% + Max (5.80%; 3M Libor +1.30%) • Worst of underlying below put barrier • 100% + Max (5.80%; 3M Libor +1.30%)minus worst underlying performance

  14. DISCLAIMER The information in this document is derived from sources believed to be reliable but which have not been independently verified. Catley Lakeman Securities makes no guarantee of its accuracy and completeness and is not responsible for errors of transmission of factual or analytical data, nor is it liable for damages arising out of any person’s reliance upon this information. All charts and graphs are from publicly available sources or proprietary data. The opinions in this document constitute the present judgment of Catley Lakeman Securities, which is subject to change without notice. This document is neither an offer to sell, purchase or subscribe for any investment nor a solicitation of such an offer. This document is intended for the use of institutional and professional customers and is not intended for the use of private customers. This document is not intended for distribution in the United States of America or to US persons. This document is intended to be distributed in its entirety. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. Catley Lakeman Securities is a LLP registered in England and Wales, Registered Office : One Eleven Edmund Street, Birmingham, B3 2HJ. Registration Number: OC336585, FSA Reference: 484826

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