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Section 7. Bond Portfolio Management

Section 7. Bond Portfolio Management. Yogo Purwono, M.M, FRM . Portfolio strategy. Passive Buy and holds Tracking index Active Portfolio diversification Immunization Duration based hedging etc. Modern portfolio theory. It is a single period model

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Section 7. Bond Portfolio Management

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  1. Section 7. Bond Portfolio Management Yogo Purwono, M.M, FRM

  2. Portfolio strategy • Passive • Buy and holds • Tracking index • Active • Portfolio diversification • Immunization • Duration based hedging • etc

  3. Modern portfolio theory • It is a single period model • It can be used to measure and control aggregate credit risk exposure • The inputs are: • Expected return of each bond in the portfolio • Standard deviation of the bond’s return in the portfolio • Correlation coefficient of returns between two bonds in the portfolio

  4. Modern portfolio theory • For each portfolio, we need to calculate its expected return and volatility (standard deviation of portfolio return) • The investor’s problem is: max ERp = sum WjERj subject to VOLp = given sum Wj = 1 Wj > 0

  5. KMV portfolio manager model • Rj = AISj – ELj = AISj – [EDFj x LGDj] • Sigma j = ULj = Sigma Dj x LGDj = sqrt[EDFj x (1 – EDFj)] x LGDj • RHOij = correlation between the systematic return component of the equity returns of bond issuer i and j Where • AIS = annual fees earned + bond rate – cost of fund • Sigma Dj = volatility of the loan’s default rate

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