2017 CFA Level 3 Fixed Income

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2017 CFA Level 3 Fixed Income by Mind Map: 2017 CFA Level 3 Fixed Income

1. Fixed Income 1

1.1. Managing funds agains a liability using ALM

1.1.1. Dedication Strategies Immunization Strategies Cash Flow Matching Strategy Structuring Cash Flows of assets/portfolio to match up with liability Cash Flows. Work backwards when matching cash flow payments to liability payments. Limitations of Cash Flow Matching Extensions of CF Matching Contrasting an Immunization strategy to a Cash Flow Matching strategy Applying any dedication strategy, a PM is concerned with: Universe Selection Optimization Monitoring Transaction Costs

1.1.2. Classes of Liabilities Principal Repayment: Amount & Timing of Liability are known Life Insurance payment: Known amount but unknown timing. Floating rate annuity payout: Unknown amount but known timing liability Post-retirement health care benefits: Unknown timing & amount of liability.

1.1.3. Rebalance ratio

1.2. Managing Funds against a bond market index

1.2.1. Classification of Fixed Income Strategies Passive Strategies Indexing: Pure & Enhanced 3 Techniques to align Risk Exposure with Bond Index Active Strategies Active mgmt by larger risk factor mismatches Full Blown active management Extra Activities required by active managers

1.3. Choosing a BM for AO or ALM approach

1.3.1. If choosing to go with an INDEX (passive) approach Benchmark selection: 4 characteristics to match your INDEX fund against the benchmark with. 1) Market Risk 2) Income Risk 3) Credit Risk 4) Liability Framework Risk In addition: Returns and Risk need to be evaluated on after tax basis. BB example of index benchmark selection based on what is important to the investor. Risk in Detail: Risk Profile A major source of risk for most bonds: Yield Curve The BUMs problem A cap weighted index is made up of highly leveraged issuers which, as a result, run the risk of being downgraded.

2. Fixed Income 2

2.1. Using Leverage to enhance returns

2.1.1. Repurchasing agreements (Repo or RP) The logic behind a PM doing this is that in hopes of capturing a higher return than the borrowing cost. Dealers are the individuals we would lend our security to and who would provide us the funds to lever up. The 6 factors that a more attractive/lower rates for repos. Physical delivery Seasonal factors affecting supply & demand Demand for the underlying security Term to maturity Transfer of Securities

2.2. Using Derivatives to manage risks associated with bond portfolio management

2.2.1. Derivative enabled strategies Interest rate futures When to buy vs. sell interest rate futures contracts. Advantages of using interest rate futures vs. using cash market. (aka outright buying and selling bonds) Interest Rate Swaps How to alter duration (interest rate risk) of a portfolio using swaps. Interest Rate Options Bond Options and duration Hedging with options Structured Products What to do based on interest rate outlook. If not sure where rates will be. If you believe rates will not move much in either direction. If you strongly believe rates will drop If you strongly believe rates will increase

2.2.2. Credit Risk and 5 methods for managing Credit Risk Credit Derivatives Credit Default "Swap" Credit "Options" Credit "Forward" Contract

2.2.3. Other risk meausres Semivariance Measures dispersion of returns below a target return Disadvantage Shortfall Risk It is appropriate for analyzing risk that is not normally distributed. Disadvantage Measures only the "probability" of not achieving some specified return target. VaR Gives an estimated probability that losses will exceed a certain level over a specified time period. Disadvantage

2.3. International Bond Investing

2.3.1. Which international bond to invest in?

2.3.2. Proxy Hedge

2.3.3. Currency Risk Comparing Hedged Returns across markets BB To hedge or not hedge (you'll notice that all the examples say "assuming IRP holds") I don't think they give an example where IRP does not hold. So don't worry/think to much about what IRP means. Example 1 BB Example 2 BB EOC FI 2 Example from 2016 morning essay (scenario)

2.3.4. Do we pursue active or passive management? Active management decisions on where value can be added. Currency: To hedge currency risk or not. Duration: Foreign bond duration contribution to portfolio and using Hedge Ratio Within intl. bonds themselves, where do opportunities lie. Yield Curve: Breakeven yield curve analysis. Sector Selection: Govts, corporates... Credit: ability to anticipate credit upgrades and downgrades. Investing outside the bond benchmark.

2.3.5. Breakeven Spread Analysis Sample BB Sample EOC 22 Answer Scenario Sample EOC 8 Question Answer

2.3.6. Emerging Market Debt (Investing in) Pro Have access to IMF if they need money which provides a secondary source of liquidity. They can react quickly to negative events Many possess large FX reserves. Con Returns exhibit negative skewness Lack transparency and court tested laws that a developed country offers. Less protected from political influence to a EMD investors disadvantage. (corrupt govt) Analyzing EMD Political Risk Does the country have sound ways to collect revenue via taxes. Export/Import friendly.

3. Definitions

3.1. Economic Surplus

3.2. ALM uses the Liability Relative Approach to build a Liability Mimicking Portfolio.

3.2.1. Liability Relative Approach covers matching the liabilities of a pension with "a like" asset. Nominal bonds to non inflation adjusted benefit payments....

3.2.2. ALM just explains the need approach that matches the assets duration to the liabilities duration. ALM vs. MVO

3.2.3. Liability Mimicking Portfolio is one that is designed relative to

3.3. Durations

3.3.1. Effective Duration

3.3.2. Key Rate Duration

3.4. Convexity

4. Relative Value Methodologies

4.1. What is relative value analysis in the bond world?

4.2. 2 approaches to Global Credit bond portfolio Management (or a combination of both approaches)

4.2.1. Top-Down Goal: form views on large-scale economic and industry developments. Which then:

4.2.2. Bottom Up Goal: hope to outperform their benchmark due to superior security selection, while maintaining neutral weightings to the various sectors in the benchmark Notice: they maintain neutral weightings to the various sectors in the benchmark. Find good bond investments based on price of that issue relative to another peer bonds issue.

4.2.3. "Classic Relative Value Analysis" combines both bottom up and top down approaches.

4.3. 9 Methods to add value using Relative Value approach (RV Methodologies) during the portfolio construction process.

4.3.1. Total Return Analysis

4.3.2. Primary Market Analysis New Issues coming to market cause secondary issue bond prices to go up (ylds down) due to price validation from the new issues.

4.3.3. Secondary Trading rationales and constraints analysis. 8 Common reasons to trade in the secondary market. Yield/spread pick up trade Credit Upside trade Swapping out old issue and replacing with new issue (New issue swap trades) Industry/Sector rotation trade Curve Adjustment trade Structure Trade Cash Flow reinvestment trades Credit Defense trade Trading constraints and the IPS Portfolio Constraints. Story Disagreement Buy & Hold Seasonality

4.3.4. Liquidity and Trading Analysis less liquid securities offer a higher yld but incur higher costs as a result of illiquidity. Large corporate bond issues will be more liquid than small private placement issuances.

4.3.5. Spread Analysis Mean Reversion Analysis Trades Upon computing the results you say "XYZ bond is the appropriate bond to purchase because its credit spread is the largest number of standard deviations above the mean. It's spread is more likely to contract than the spreads on the other two bonds".

4.3.6. Structural Analysis

4.3.7. Credit Curve Analysis

4.3.8. Credit Analysis

4.3.9. Asset Allocation/Sector Analysis

4.4. Relative Value

4.4.1. Relative Value Analysis

4.5. The Fixed Income Portfolio Management Process