WHICH OF THE CRITERIA OUTLINED BY ALPHA IS LEAST ACCURATE WITH RES...

36. Which of the criteria outlined by Alpha is least accurate with respect to the selection of a fixed

income manager?

A. Criterion 1

B. Criterion 2

C. Criterion 3

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Kamiko Watanabe Case Scenario

Kamiko Watanabe, CFA, is a portfolio advisor at Wakasa Bay Securities. She specializes in the use of

derivatives to alter and manage the exposures of Japanese equity and fixed income portfolios. She has

meetings today with two clients, Isao Sato and Reiko Kondo.

Sato is the manager of the Tsushima Manufacturing pension fund, which has a target asset allocation of

60% equity and 40% bonds. The fund has separate equity and fixed income portfolios, whose

characteristics are provided in Exhibits 1 and 2. Sato expects equity values to increase in the coming two

years and, in order to avoid substantial transaction costs now and in two years, would like to use

derivatives to temporarily rebalance the portfolio. He wants to maintain the current beta of the equity

portfolio and the current duration of the bond portfolio.

Exhibit 1: Tsushima Pension Fund

Equity Portfolio Characteristics

Current market value JPY27.5 billion

Benchmark Nikkei 225 Index

Current beta 1.15

Exhibit 2: Tsushima Pension Fund

Bond Portfolio Characteristics

Benchmark Nikko Bond Performance Index

composite

Current duration 4.75

In order to rebalance the pension fund to its target allocations to equity and bonds, Watanabe

recommends using Nikkei 225 Index futures contracts, which have a beta of 1.05 and a current contract

price of JPY1,525,000, and Nikko Bond Performance Index futures, which have a duration of 6.90 and a

current contract price of JPY4,830,000. She assumes the cash position has duration of 0.25.

Sato wants to know if other derivatives could be used to rebalance the portfolio. In response, Watanabe

describes the characteristics of a pair of swaps that, together, would accomplish the same rebalancing

as the proposed futures contracts strategy.

Kondo manages a fixed income portfolio for the Akito Trust. The portfolio’s market value is JPY640

million, and its duration is 6.40. Kondo believes interest rates will rise and asks Watanabe to explain how

to use a swap to decrease the portfolio’s duration to 3.50. Watanabe proposes a strategy that uses a

pay-fixed position in a 3-year interest rate swap with semi-annual payments.

Kondo decides he wants to use a 4-year swap to manage the portfolio’s duration. After some

calculations, Watanabe tells him a pay-fixed position in a 4-year interest rate swap with a duration of –