Final Term Project

Directions: Read the following Case and answer all the questions. Please submit your work to the Dropbox by midnight Sunday CT.

Following is a portfolio consisting of 50 bonds with a market value of $ 99,999,999 as of April 29, 2011:

Table 1: 50-bond Portfolio

IdentifierDescriptionSectorMarket Value
003723AAABN AMRO BANK NVCorp. Financials1,422,596
251591AYDEVELOPERS DIVERS REALTYCorp. Financials644,344
381427AAGOLDMAN SACHS CAPITAL IICorp. Financials2,761,546
58551TAAMELLON CAPITAL IVCorp. Financials3,102,915
912810PWUS TREASURY BONDSTreasury804,588
912810QAUS TREASURY BONDSTreasury7,505,533
912810QKUS TREASURY BONDSTreasury4,048,097
912828PAUS TREASURY NOTESTreasury3,378,751
912828PFUS TREASURY NOTESTreasury20,596,365
00104BACAES EASTERN ENERGYCorp. Utilities1,206,446
165167BSCHESAPEAKE ENERGY CORPCorp. Utilities880,013
125896BGCMS ENERGYCorp. Utilities1,337,697
665772CENORTHERN STATES PWR MINNCorp. Utilities907,113
797440BMSAN DIEGO GAS & ELECTRICCorp. Utilities856,840
FGB08000FHLM Gold Guar Single F. 30yrMBS Agency3,040,911
FGB07001FHLM Gold Guar Single F. 30yrMBS Agency780,262
FGB06402FHLM Gold Guar Single F. 30yrMBS Agency1,004,579
FGB07002FHLM Gold Guar Single F. 30yrMBS Agency4,235,068
FGB05403FHLM Gold Guar Single F. 30yrMBS Agency1,531,707
FGB06003FHLM Gold Guar Single F. 30yrMBS Agency1,537,027
FGB06004FHLM Gold Guar Single F. 30yrMBS Agency700,545
FGB05011FHLM Gold Guar Single F. 30yrMBS Agency690,585
FNA07098FNMA Conventional Long T. 30yrMBS Agency1,014,899
FNA08000FNMA Conventional Long T. 30yrMBS Agency1,883,297
FNA05402FNMA Conventional Long T. 30yrMBS Agency1,854,853
FNA06402FNMA Conventional Long T. 30yrMBS Agency1,311,433
FNA07002FNMA Conventional Long T. 30yrMBS Agency2,563,939
FNA05003FNMA Conventional Long T. 30yrMBS Agency684,085
FNA05403FNMA Conventional Long T. 30yrMBS Agency3,469,103
FNA06003FNMA Conventional Long T. 30yrMBS Agency1,715,870
FNA05010FNMA Conventional Long T. 30yrMBS Agency843,855
FNA05011FNMA Conventional Long T. 30yrMBS Agency1,173,465
GNB04411GNMA II Single Family 30yrMBS Agency2,509,580
91311QADUNITED UTILITES PLCCorp. Industrials848,272
02051PACALON REFINING KROTZCorp. Industrials630,655
101137ADBOSTON SCIENTIFCCorp. Industrials1,656,030
12527GAACF INDUSTRIES INCCorp. Industrials1,499,778
582834AMMEAD CORPCorp. Industrials787,191
651715AFNEWPAGE CORPCorp. Industrials1,603,501
723787AGPIONEER NATURAL RESOURCESCorp. Industrials1,045,275
749685AQRPM INTERNATIONAL INCCorp. Industrials642,823
784635AMSPX CORPORATIONCorp. Industrials766,621
915436AFUPM-KYMMENE CORPCorp. Industrials648,265
962166AVWEYERHAEUSER COCorp. Industrials871,588
46513E5YISRAEL STATE OF-GLOBALGov. Related1,911,761

Table 2: Asset Class

The benchmark for the manager who has constructed this portfolio is a composite index consisting of one-third each of the Barclays Capital U.S. Treasury index, Barclays Capital U.S. Credit Index, and Barclays Capital U.S. MBS index. First, in regards to the Barclays Capital U.S. Treasury index, this index measures the performance of U.S. Treasury securities. Second, in regards to the Barclays Capital U.S. Credit Index, this index includes both corporate and non-corporate sectors where the corporate sectors are industrial, utility, and finance that include both U.S. and non-U.S. corporations. The non-corporate sectors are sovereign, supranational, foreign agency, and foreign local government. The index is calculated monthly on price-only and total-return basis. All returns are market value-weighted inclusive of accrued interest. Third, in regards to the Barclays Capital U.S. MBS index, this index measures the performance of investment grade fixed-rate mortgage-backed pass-through securities of GNMA, FNMA, and FHLMC.

Asset ClassPortfolioBenchmark
Government Related?6.8
Corporate Industrials?13.9
Corporate Utilities?2.9
Corporate Financials?9.7
MBS Agency?33.3

Table 3.1: Analytics for the 50-bond Portfolio and the Benchmark

Table 3.1 provides information about the relative exposure to interest rate risk as measured by duration, spread risk as measured by spread duration, and call/prepayment risk as measured by vega, as well as the convexity.

Spread Duration6.775.271.50

Table 3.2: Contribution to Duration by Asset Class for the 50-bond Portfolio

Table 3.2 provides information about the portfolio’s relative risk exposure to interest rate risk.

Duration ContributionPortfolioBenchmarkDifference
Government Related0.920.410.51

Table 4: Monthly Tracking Error for Risk Factors

Risk Factor CategoriesIsolated Risk/Tracking Error
Swap Spreads2.5
Spread Government Related5.3
Spread Corporate30.6
Spread Securitized5.8

Table 5: Volatility table.

This table provides the breakdown of the standard deviation of the returns for the portfolio and the benchmark

VolatilityPortfolioBenchmarkTracking Error
Duration Beta?

Table 6: Detailed Monthly Tracking Error for the 50-Bond Portfolio by Risk Factor Group

The “risk factor group” table provides information about the portfolio risk across the different categories of risk factors. Shown are the systematic risk and the idiosyncratic risk and six components of systematic risk. The “contribution to TEV” column shows the isolated tracking error. The contribution to tracking error for each group of risk factor is shown in the “liquidation effect on TEV” column.

Risk Factor GroupIsolated TEVContribution to TEVLiquidation Effect on TEVTEV Elasticity (%)
Systematic Risk37.933.2–22.40.8
Swap Spreads2.50.2–0.10.0
Spread Government Related5.
Spread Corporate30.610.00.80.2
Spread Securitized5.8–
Idiosyncratic Risk18.79.1–4.20.2


The purpose of this project is to describe in detail the risk characteristics of the 50-bond Portfolio. Your instructor drew up the following list of questions that should be covered to be able to discuss the portfolio’s risk relative to the benchmark. In your analysis, be sure to discuss where it seems like the manager is taking views on the market.

1. Use the data in Table 1 to calculate the missing weights for each class asset that appear in Table 2. After completing the missing weights, start your analysis of table 2 by comparing the portfolio to that of benchmark in terms of the allocation to the major sectors of the benchmark (i.e., overweighting/underweighting). Discuss your results.

2. Do you think the portfolio manager can use the percentage allocation to each sector (i.e., Asset class table) to evaluate the portfolio’s exposure to various risk factors? Explain?

3. Use the data in Table 3.1 and 3.2 to assess the portfolio risk relative to the benchmark? Make sure to discuss the sources of risk (i.e., interest rate risk, spread risk, and call & prepayment risk). Before starting your analysis, explain the differences among interest rate risk, spread risk, and call & repayment risk.

4. What is tracking error? What is meant by tracking error due to systematic risk factors? What is meant by isolated tracking error? Briefly explain what is meant by yield curve risk, swap spread risk, volatility risk, government-related spread risk, corporate spread risk, and securitized spread that are listed in table 4 and the (monthly) volatility of these risk factor categories?

5. Compute the isolated systematic tracking error for the portfolio given the monthly tracking error for each risk factor exposure in Table 4? Discuss the implications of your results for the risk exposure of this portfolio. Make sure to assume a zero correlation between any pair of risk factors when calculating the portfolio isolated systematic tracking error.

6. Why is the tracking error more important than portfolio variance of returns when a portfolio manager’s performance is measured versus a benchmark?

7. You are reviewing table 5 that indicates that a portfolio tracking error is 143.2 basis points. It is also reported that the tracking error due to systematic risk is 141.9 basis points and the tracking error due to non-systematic risk is 19.3 basis points. Why doesn’t the sum of these two tracking error components total up to 161.2 basis points?

8. Calculate the total risk for the benchmark using the values in the “volatility” Table (i.e., Table 5) and portfolio tracking error (volatility of net position). Complete the related blank in Table 5.

9. How can a multi-factor risk model be used to monitor and control portfolio risk? Explain whether you agree or disagree with the following statement “It is the tracking error not the idiosyncratic risk (as measured by the standard deviation of the idiosyncratic returns) that the manager must consider in portfolio construction and monitoring”. Use Table 5 to support your argument.

10. Compute the duration beta using the values in the “analytics” table (Table 3.1). Complete the related blank in Table 5. Explain your answer.

11. Based on the information given in Table 6, what are the major risk exposures of the 50-bond portfolio? Explain your answer.

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