Questions 49 to 54 relate to Portfolio Management of Global Bonds
Kingsbridge Case Scenario
London-based Kingsbridge Partners has been selected to manage a GBP150 million global bond portfolio
for a pension fund. Jonathan Bixby, CFA, Kingsbridge’s portfolio manager, meets with Iain Seymour, CFA,
a fixed income analyst at the firm to review the portfolio and its holdings relative to the client’s
objectives.
The pension fund allows the use of 100% leverage to generate incremental returns. Bixby evaluates the
use of leverage in the portfolio using the data in Exhibit 1.
Exhibit 1
Asset and Liability Data
Assets Liabilities
Portfolio (GBP millions) 300 150
Duration 5.50 1.00
Expected return or cost (%) 4.75 3.95
Bixby’s current macro view is that the economy is growing at a rate above the trend rate and, as a result,
interest rates are likely to rise. Given his view, he is concerned the duration of the portfolio is
inappropriate and plans to use the futures market to manage its interest rate risk. His new duration
target for the asset portfolio is 4.25, and he uses the data in Exhibit 2 to reposition the portfolio.
Exhibit 2
Futures Market Data
Futures contract price GBP100,500
Conversion factor 1.12
Duration of cheapest-to-deliver bond 5.3
Price of cheapest-to-deliver bond GBP97,750
Seymour tells Bixby, “International interest rates are not perfectly correlated. We can see the impact of
a change in U.S. interest rates on our model global bond portfolio. This portfolio contains U.S. and
German bonds and is not currently hedged with regard to currency or interest rates. Our analysis shows
that the country beta between the United States and Germany is 0.62.” Model global bond portfolio
data is provided in Exhibit 3.
Exhibit 3
Global Bond Model Portfolio
Duration Allocation (%)
U.S. bond issuers 6.6 60
German bond issuers 3.9 40
Bixby asks Seymour whether the model portfolio should be hedged back to its domestic currency, the
pound sterling (GBP). Bixby tells him that actively managing currency risk is an expected source of
incremental returns for the portfolio and has historically accounted for 25% of Kingsbridge’s alpha
relative to the benchmark. Seymour refers to the data in Exhibit 4 to support his current view that
currency exposure in the portfolio should be actively managed.
Exhibit 4
Currency Market Data
U.S. Eurozone U.K.
Risk free rate – one year 0.25% 1.50% 0.90%
Spot rate (GBP per USD or EUR) 0.6098 0.8929 NA
Forward rate (GBP per USD or EUR) 0.6137 0.8875 NA
Kingsbridge forecast spot rate in one year 0.6173 0.8850 NA
Bixby asks whether this global portfolio would benefit from including emerging market debt securities.
Seymour responds that returns can be attractive in emerging markets during certain periods, but risks
also abound. He notes the following risks:
Risk 1: Returns are frequently characterized by significant negative skewness because the
potential large downside is not offset by a comparable upside.
Risk 2: Emerging markets offer less protection from interference by the executive branch than
developed countries.
Risk 3: Emerging market countries have limited access to secondary sources of liquidity.
Finally, Seymour asks Bixby if he plans to purchase mortgaged-backed securities (MBS) in the portfolio.
Bixby responds, “Yes; because MBS spreads are cheap relative to historical levels, I can buy MBS, hedge
the interest rate risk by shorting Treasuries, and capture the OAS. By
matching the dollar duration of the Treasury position with the dollar duration of the mortgage security, I
will have a stable hedge.”
49. Based on the data in Exhibit 1, the duration of the equity in the leveraged portfolio is closest to:
A. 4.50.
B. 5.00.
C. 10.00.
50. Given Bixby’s new target duration and the data in Exhibits 1 and 2, the most appropriate action
using Treasury futures is to sell:
A. 646 contracts.
B. 789 contracts.
C. 811 contracts.
51. Based on Seymour’s statement regarding international interest rates, as well as the data in
Exhibit 3, the impact of a 100-basis-point decline in U.S. interest rates on the model portfolio’s
value is closest to:
A. 3.41%.
B. 4.02%.
C. 4.93%.
52. Based on the data in Exhibit 4, the most likely action that Kingsbridge would take to actively
manage the portfolio’s currency exposure in the currency forward markets is to sell:
A. USD and buy EUR.
B. EUR and buy USD.
C. USD, sell EUR, and buy GBP.
53. Seymour is least likely correct with respect to which risk regarding investing in emerging market
debt?
A. Risk 1
B. Risk 2
C. Risk 3
54. Will Bixby’s strategy to hedge his purchases of MBS most likely be effective?
A. Yes
B. No, because one security in the transaction amortizes and the other does not
C. No, because when interest rates decline, the durations of the two securities will change by
different amounts
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