Running Head: GBA

GBA

Name of the Writer

Name of the Institute

Date
Running Head: GBA

Introduction

GBA manages the portfolio of fixed income majorly for the endowments and pension plans who

are in required of fixed stream of income, GBA currently manages a portfolio of approx $1.7

billion and composed of seven fund managers, GBA continuously acquire new clients and looses

a few.

The GBA trading strategy majorly depends on its quantitative analysis and often gets the

advantages of kink in the yield curve. Which seems to be not a regular opportunity and GBA will

get the opportunity once in as many years. However, predicting yield curve is not an easy task

and requires specialization, skill and expertise.

There are different types of yield curve; yield curve includes normal, steep, flat and inverted.

Normal Yield Curve

In normal yield curve, short-term debt securities have a smaller yield than long-term debt

securities. The shape of the normal yield curve is upward sloping.

Steep Yield Curve

Steep Yield can be upward or downward trajectory, which indicates a steep increase or decrease

of interest rates and shows volatility. Steepening of yield curve typically indicates investor

expectations for rising inflation; increase in economic growth, since improving growth causes

the demand for longer term capital to flow to long-term bonds.

Flat Yield Curve

In flat yield curve, the yield is flat throughout the period, and curve is a straight line which

indicates the normal and flat yield. The term flattening yield curve is very technical terminated

and does not sound as straight as it sounds, but, in fact, the concept is very simple. When the

yield curve flattens, it means that the spread between the yields on short-term bonds and long-

term bonds decreases, making the curve appear less steep or flat. The narrow of the spread

indicates that yields on long-term bonds are falling faster than yields on short-term Treasury

bonds or, occasionally, which short-term bond yields are raising even as long-term yields are

falling

.Inverted Yield Curve

In inverted yield curve the curve is inverted and in which long-term interest rates are lower than

short-term interest rates this type of yield curve is rare in the main curve types and is considered

to be a predicting of economic recession.

On the rare occasions when a yield curve become flat to the point that short-term interest rates

are higher than long-term interest rates the curve is said to be inverted. Typically, an inverted

curve is the indication of the recession. The reason behind the formation of the inverted curve is

for this is that investors will bear low rates at present if they have confidence that rates are going

to fall even lower further in near future.

Need to test the (Porche) bond as of June 20, 1997 as showing in Exhibit 8.  Using time

value formulas, present value, future value, payments, and interest rate, showing why it is

priced at 120.885.
Running Head: GBA

The Porches bond is valued at $123.88 using the present value of cash flow methodology. This

price is dirty and includes accrued interest. The accrued interest is $3, when subtracted from

$123.88 it will give a clean bond price. Clean bond price is the price of a bond excluding any

interest that has been accrued since issue or the most recent coupon payment when bond change

hands... This is to be compared with the dirty price, which is the price of a bond including the

accrued interest.

The Porches Bond is paying 4.5% semiannual coupon and will mature in 14 years time, the YTM

of the comparative bond is with same coupon rate, and maturity is 6.098%. Using this

information if the present value of future cash flow is calculated the price of the bond will be

$127. The price of the bond is suggesting that it is trading on the premium because it is paying a

coupon rate greater than the average market interest rates.

Bonds are priced at a discount, premium, or at par. If the bond's id traded at a price that is higher

than its par value, it would sell at a premium like in Porches case because its interest rate is

higher than current prevailing market rates. If the price of bonds is trading at the lower than its

par value, it means that bond is selling at a discount because its coupon payment is lower than

current market interest rates.

Investor required rate of return is the interest rate that a bond needs to pay in order to encourage

investors to buy. The value of a bond will increase or decrease depends upon prevailing interest

rates in the market.

Concepts of duration and convexity.

Duration is a measure of the sensitivity of the price of the bond due to changes in interest rates.

Duration answer is expressed in a number of years. Rising interest rates mean falling bond
Running Head: GBA

prices, when interest rates decline which mean rising bond prices. While Convexity is a measure

of the curvature in the relationship between bond prices and bond yields that explains how the

duration of a bond changes as the interest rate changes. Between June and September tools such

as duration and convexity can be used to measure the risk of change in the price of the bond due

to changes in interest rates

Duration can be calculated using Macaulay duration formula, the duration is also called effective

duration, GBA can calculate the duration of its bond portfolio and can assess the risk of the

portfolio using duration due to changes in interest rates.

Assessment of GBA performance and comment on the appropriateness of the selected

benchmark.

GBA performance can be assessed by comparing the difference between the yield GBA have

earned as compared to its SCM Index, In year 1988 GBA earned annualized return of 14.43%

while SCM is showing figure of 14.94% which translates fifty basis points less than the SCM

index, the performance of the GBA is in year 1989 GBA earned seventy three basis points less,

in year 1990 it losses more than one hundred forty-five basis points than its bench mark, in year

1991 the loss was recovered and earned two hundred sixty five basis points above to its

benchmark, in 1992 the positive trend continue and end one hundred twenty-three basis points,

in year 1993 GBA only exceeded by fifty-six basis points in year 1994 the negative trend return

and loosed twenty-two basis points, in year 1995 only forty-six basis points above, in year 1996

only thirty-eight basis points above was earned ,while in year 1996 only thirty-eight basis points

was earned in year 1997 only twenty-four basis points was earned.
Running Head: GBA

GBA investment style majorly replies on quantitative value strategies nearly 80% of investment

is made through while remaining 20% on interest rate anticipation.GBA bond portfolio includes

short to long term bond with mostly government issued bonds.

SCM Universe Bond Total Return Index is a broad measure of total return for the Canadian bond

market, covering approximately seven hundred marketable Canadian bonds with a term to

maturity of more than one year. Bond categories in different types including Federal, Provincial,

Municipal and AA through BBB-rated corporate issuers

GBA evaluates its bond portfolio return performance through comparison with an SCM bond

index, the composition of GBA portfolio and the SCM bond index should be same in order to

match and track performance adequately. GBA and SCM bond portfolio composition differs

significantly, GBA portfolio includes majorly government bonds of different maturities with

average portfolio duration of 5.65 years, while SCM bond portfolio composed of municipal

bonds, corporate debentures, federal bonds and provincial bonds with different maturities.

Hence bench mark that GBA opt to access it performance significantly vary because of a change

in a composition and its style of trading.

Further composition of index changes over the time, so GBA must include and exclude in order

to track with index which it chose for this benchmark, so it can be concluded that GBA bench

mark is not relevant for it type of investment style, type of bonds and maturities and should be

changed with relevant one.

According to the info in the fixed income report, assess the outlook for interest rate change.

Showing the applicability on the discussion of this case.

A global bank is increasing the interest rates and in reaction Bank Of Canada also increased the

interest rate on 1st October, this will by largely impact on prices of bond there is an inverse

relation between price of the bond and interest rate, when interest rate increases the price of bond

decline and vice versa.

Increase and decrease of interest rate are decided in monetary policy which is set by the central

bank, monetary policy attempt to stimulate the economy, and control the supply of money. The

Canadian Government is heavily depending upon tight fiscal policy and easy monetary policy

when means interest rates will remain low and will not increase thus it is positive for the bond

market.

So it can be concluded that GBA will continue to make a positive return if rates are central bank

will not increase the interest rates

9/1/9 3.05
7 0.17 0.33 4.5 % 0.97 4.3669
3/1/9 3.05
8 0.67 1.33 4.5 % 0.94 4.2376
9/1/9 3.05
8 1.17 2.33 4.5 % 0.91 4.1123
3/1/9 3.05
9 1.67 3.33 4.5 % 0.89 3.9906
9/1/9 3.05
9 2.17 4.33 4.5 % 0.86 3.8725
3/1/0 3.05
0 2.67 5.33 4.5 % 0.84 3.7579
9/1/0 3.05
0 3.17 6.33 4.5 % 0.81 3.6468
Running Head: GBA

3/1/0 3.05
1 3.67 7.33 4.5 % 0.79 3.5389
9/1/0 3.05
1 4.17 8.33 4.5 % 0.76 3.4341
3/1/0 3.05
2 4.67 9.33 4.5 % 0.74 3.3325
9/1/0 10.3 3.05
2 5.17 3 4.5 % 0.72 3.2339
3/1/0 11.3 3.05
3 5.67 3 4.5 % 0.70 3.1382
9/1/0 12.3 3.05
3 6.17 3 4.5 % 0.68 3.0454
3/1/0 13.3 3.05
4 6.67 3 4.5 % 0.66 2.9553
9/1/0 14.3 3.05
4 7.17 3 4.5 % 0.64 2.8678
3/1/0 15.3 3.05
5 7.67 3 4.5 % 0.62 2.7830
9/1/0 16.3 3.05
5 8.17 3 4.5 % 0.60 2.7006
3/1/0 17.3 3.05
6 8.67 3 4.5 % 0.58 2.6207
9/1/0 18.3 3.05
6 9.17 3 4.5 % 0.57 2.5432
3/1/0 19.3 3.05
7 9.67 3 4.5 % 0.55 2.4680
3/1/0 10.1 20.3 3.05
7 7 3 4.5 % 0.53 2.3949
9/1/0 10.6 21.3 3.05
8 7 3 4.5 % 0.52 2.3241
3/1/0 11.1 22.3 3.05
8 7 3 4.5 % 0.50 2.2553
9/1/0 11.6 23.3 3.05
9 7 3 4.5 % 0.49 2.1886
3/1/0 12.1 24.3 3.05
9 7 3 4.5 % 0.47 2.1238
9/1/1 12.6 25.3 3.05
0 7 3 4.5 % 0.46 2.0610
3/1/1 13.1 26.3 3.05
0 7 3 4.5 % 0.44 2.0000
9/1/1 13.6 27.3 104. 3.05
1 7 3 5 % 0.43 45.0703
127.0643