A university endowment fund has sought your advice on its fixed-income portfolio strat- egy. The characteristics of the portfolio's current holdings are listed below:
|
Bond
|
Credit Rating
|
Maturity (yrs.)
|
Coupon Rate (%)
|
Modified Duration
|
Convexity
|
Market Value of Position
|
|
A
|
U.S. Govt.
|
3
|
0
|
2.727
|
9.9
|
$30,000
|
|
B
|
A1
|
10
|
8
|
6.404
|
56.1
|
30,000
|
|
C
|
Aa2
|
5
|
12
|
3.704
|
18.7
|
30,000
|
|
D
|
Agency
|
7
|
10
|
4.868
|
32.1
|
30,000
|
|
E
|
Aa3
|
12
|
0
|
10.909
|
128.9
|
30,000
|
|
|
|
|
|
|
|
$150,000
|
a. Calculate the modified duration for this portfolio (i.e., Mod Dp).
b. Suppose you learn that the implied sensitivity (i.e., modified duration) of the endow- ment's liabilities is about 6.50 years. Identify whether the bond portfolio is: (1) immu- nized against interest rate risk, (2) exposed to net price risk, or (3) exposed to net reinvestment risk. Briefly explain what will happen to the net position of the endow- ment fund if in the future there is a significant parallel upward shift in the yield curve.
c. Briefly describe how you could increase the convexity of the portfolio while keeping the modified duration at the same level.
d. Your current active view for the fixed-income market over the coming months is that Treasury yields will decline and corporate credit spreads will also decrease. Briefly dis- cuss how you could restructure the existing portfolio to take advantage of this view.