Video Lesson Day #8-Duration analysis CFA Exam Question Frank Myers, CFA, is a f
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Video Lesson Day #8-Duration analysis CFA Exam Question Frank Myers, CFA, is a fixed-income portfolio manager for a large pension fund. A member of the nvestment Committee, Fred Spice, is very interested in learning about the management of fixed-income portfolios. Mr. Spice has approached Mr. Myers with several questions. Mr. Myers has decided to illustrate fixed-income trading strategies using a fixed-rate bond and note. Both bonds have semiannual coupons. Unless otherwise stated, all interest rate changes are parallel. The characteristics of these securities are shown in the table below. Price Yield to maturity Periods to maturity Modified duration Fixed-Rate Bond 07.18 5.00% 18 6.9848 Fixed-Rate Note 100.00 500% 3.5851 1 Mr. Spice asks Mr. Myers how a fixed-income manager would position his portfolio to capitalize on his expectations of increasing interest rates. Which of the following would be the most appropriate strategy? a Lengthen the portfolio . duration. b Buy fixed-rate bonds c Shorten the portfolio . duration. 2 Mr. Spice asks Mr. Myers to quantify the value changes from changes in interest . rates. To illustrate, Mr. Myers computes the value change for the fixed-rate note. He assumes an increase in interest rates of 100 basis points. Which of the following is the best estimate of the change in value for the fixed-rate note? 7 b -$3.5 c $3.59 3 For an increase of 100 basis points in the yield to maturity, by what amount would . the fixed-rate bond's price change?Explanation / Answer
1)Duration is the percentage amount of change in a portfolio with one percent increase or decrease in rate. If rate increases then portfolio value decreases by duration times the rate of increase. If interest rates are expected to increase then duration must be reduced to have a less decrease in value of portfolio. Hence decrease in value of portfolio duration shall be undertaken.
Hence option c is correct
2)Change in value of portfolio = Duration *-(change in rate)
=100*3.5851*-0.01=-3.59
Hence option b is correct
3)107.18*-0.069848=-7.49
hence a is correct
4)A bigger coupon leads to a less duration as coupons cushion impact of interest rates to some extent
Hence option c is applicable
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