Section 4.1
The portfolio has to be rebalanced to match the dollar duration of the liabilities. The
liabilities have dollar duration of $4,000,000 (thousands) × 14 = $56,000,000
(thousands). The mortgage-backed securities fund is the asset class that poses
contingent claim risk, so it is being liquidated, and the $700,000 thousand is being
invested in the long corporate bond fund. The new $500,000 thousand contribution is
invested in Treasury STRIPs. The reallocated assets have dollar durations nearly identical
to the liabilities as calculated in the following table:
New
Old Market
Market
Dollar Duration
Value Duration
Strategy
(years)
Value ($
thousands) ($ thousands)
($ thousands)
Money market 175,000 175,000 0.25 43,750
Mortgage-backed
securities fund 700,000 0 3 0
Emerging market
bond fund 675,000 675,000 4.6 3,105,000
Long corporate bond
fund 1,575,000 2,275,000 14 31,850,000
Treasury STRIPs 375,000 875,000 24 21,000,000
Total 3,500,000 4,000,000 55,998,750
4.) In Priorat’s response to Rioja regarding the explanation of key measures of an index’s
profile, he is most likely correct regarding:
A. key rate duration and incorrect regarding convexity adjustment.
B. spread duration and incorrect regarding effective duration.
C. convexity adjustment and incorrect regarding key rate duration.
Answer = A
“Fixed-Income Portfolio Management—Part I,” H. Gifford Fong and Larry D. Guin
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