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


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


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