QUESTIONS 43-48 RELATE TO FIXED INCOME PORTFOLIO MANAGEMENT. QUESTIONS...

2.70% March 2021

Finally, Wilson seeks advice regarding a GBP22 million of fixed-to-floating rate note issued

by Qual-Mart one year ago. The notes were issued with a 10-year maturity, paying a

quarterly coupon of 4.1% for the first three years, then LIBOR plus 1.1% over the remaining

period to maturity.

...

Of the immunizing portfolios in Exhibit 2, which has the greatest structural risk relative to

the liabilities in Exhibit 1?

A) Portfolio P.

B) Portfolio R.

C) Portfolio S.

Structural risk exists when the distribution of the asset cash flows does not match that of the

liabilities. This can lead to a differential in performance of the assets versus liabilities when

there are large or non-parallel shifts in the yield curve. This risk is reduced by minimizing the

dispersion of cash flows in the portfolio relative to the liabilities. Convexity is related to cash

flow dispersion, and if the asset's convexity is set slightly larger than the liability convexity,

the structural risk is minimized.

Portfolio P's convexity is slightly too low. R is the best situation with convexity slightly

greater than that of the liabilities. S's convexity is well above the liability convexity of 47.75.

Therefore, S has the greatest structural risk.

For Further Reference:

Study Session 10, LOS 22.c, d, e

SchweserNotes: Book 3 p.253, 259, 265

CFA Program Curriculum: Vol.4 p.64, 78, 88

Question #44 of 60

Which of the portfolios in Exhibit 2 would be most appropriate to immunize the liabilities in

Exhibit 1?

B) Portfolio Q.

C) Portfolio R.

The first requirement for immunization is to match the BPV of the assets and liabilities. Q

has insufficient BPV and is not acceptable.

In addition, asset convexity should slightly exceed that of the liabilities. P's convexity is

slightly too low. R meets the condition of slightly more convexity than the convexity of the

liabilities. R is the acceptable choice. (R also has the highest yield, which is also desirable.)

Question #45 of 60

Assume that the Exhibit 1 liabilities were immunized by an investment in portfolio S and that