“EVALUATING PORTFOLIO PERFORMANCE” THE CANDIDATE SHOULD BE ABLE TO

43. “Evaluating Portfolio Performance” The candidate should be able to: n) differentiate between the effect of the interest rate environment and the effect of active management on fixed-income portfolio returns; o) explain the management factors that contribute to a fixed-income portfolio’s total return and interpret the results of a fixed-income performance attribution analysis; 2008 Level III Guideline Answers Morning Session – Page 36 of 40 Question: 10 Topic: Portfolio Management – Performance Evaluation Minutes: 9 Guideline Answer: PART A i. Sullivan’s outperformance is not consistent with its strategy. Other Management Effects consist of three components – sector/quality effects, security selection and transaction costs. These components generated a negative return as indicated by the -0.12% return in Other Management Effects. Sullivan’s outperformance resulted from Interest Rate Management (0.05%) and Trading Activity (0.15%). ii. Paolello’s outperformance is consistent with its strategy. The Interest Rate Management Effect (returns due to duration, convexity, and yield-curve shape change) generated an excess return of 0.58% vs. the Bond Portfolio Index. Other Management Effects and Trading Activities Return contributed to Paolello’s outperformance but were not as significant. PART B i. The expected interest rate effect of 5.76% is the expected return of the portfolio based on the implied forward rates in the term structure of Treasury securities calculated at the beginning of the period. ii. The unexpected interest rate effect of 2.53% is the difference between the actual realized return of the portfolio and the expected interest rate effect. A positive unexpected interest rate effect is consistent with unexpected falling yields or a favorable twist in the yield curve resulting in rising prices over the time period. Morning Session – Page 37 of 40 Question: 11 Topic: Portfolio Management – Global Context Reading Reference: “Currency Risk Management,” Ch. 11, International Investments, 5

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edition, Bruno Solnik and Dennis McLeavey (Addison Wesley, 2003) Purpose: To test global aspects of currency risk management. LOS: 2008-III-17-46-a