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Homework answers / question archive / A major requirement in managing a fixed-income portfolio using a contingent immunization policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio

A major requirement in managing a fixed-income portfolio using a contingent immunization policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio

Finance

A major requirement in managing a fixed-income portfolio using a contingent immunization policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio. This difference is defined as the margin of error. In this regard, assume a $400 million portfolio with a time horizon of six years. The available market rate at the initiation of the portfolio is 10%, but the client is willing to accept 9% as a floor rate to allow use of active management strategies. The current market values and current market rates at the end of Years 1, 2, and 3 are as follows:

End of Year Market Value ($ Mil) Market Yield
1 $446.5   10 %
2 548.7   9  
3 534.9   10  

Assume that semiannual compounding is used. Do not round intermediate calculations. Enter your answers in millions. For example, an answer of $1.20 million should be entered as 1.20, not 1,200,000. Round your answers to two decimal places.

  1. Calculate the required ending-wealth value for this portfolio.

    $    million

  2. Calculate the required ending-wealth value for this portfolio at the end of Years 1, 2, and 3.

    End of Year 1: $    million

    End of Year 2: $    million

    End of Year 3: $    million

  3. Compute the margin of error at the end of Years 1, 2, and 3.

    End of Year 1: $    million

    End of Year 2: $    million

    End of Year 3: $    million

  4. Indicate the action that a portfolio manager utilizing a contingent immunization policy would take if the margin of error at the end of any year had been zero or negative.

    If the margin of error at the end of any year had been zero or negative, the portfolio manager would -Select-discontinuecontinueItem 8  active management of the portfolio and immunize it.

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(a) Ending wealth value of portfolio = portfolio amount * (1+flat rate)n

$400 million * (1 + (9%/2))(2*6) = $678.35 million

(b) & (c) Ending wealth value of portfolio & margin of error for year 1, 2 & 3:

A B C D=B-C
Year Market Value Required Market Value Margin of error
1 $                 446.50 $                 416.45 $                    30.05
2 $                 548.70 $                 477.01 $                    71.69
3 $                 534.90 $                 506.20 $                    28.70

Required market value: Portfolio wealth * (1/(1+r)n)

at the end of year 1 = 678.35 * (1/(1+(10%/2))((6-1)*2) = $416.45 million

at the end of year 2 = 678.35 * (1/(1+(9%/2))((6-2)*2) = $477.01 million

at the end of year 3 = 678.35 * (1/(1+(10%/2))((6-3)*2) = $506.20 million

(d) If the margin of error at the end of any year had been zero or negative, the portfolio manager would discontinue active management of the portfolio and immunize it.

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