Bond indexation, Financial Management

Assignment Help:

Bond indexation serves the purpose of replicating the performance of a predetermined benchmark as closely as possible. These benchmarks are generally very broader in terms of number of bonds encompassed. For example, in countries like US and Europe, the most common indices include several thousands bonds. Further, the turnover on indices is substantially quite large. This is because of substantial proportion of the bonds maturing each year and significant amounts being issued each year. Very frequently, large segments of bond market behave illiquid. Hence, futures on bond indices are currently a rare phenomenon. In general they are based on notional bonds.

Now, let us discuss about indexing technology. In this section, we will focus on stratified and optimization sampling techniques.

  • Stratified Sampling: Stratified sampling aims to limit the number of bonds included in the indexed portfolio and also avoid trading too small bond positions. In addition, it also tries to avoid being in the illiquid segment of the market. Under stratified sampling, an indexed portfolio is constructed through following below given steps:

-

Initially, the universe of bonds in the benchmark is divided into cells on the basis of certain characteristics of bonds. The characteristics include coupon, term to maturity duration, quality rating and sector etc. Subsequently, the weight of each cell is determined given the weights of bonds in the benchmark.

-

In the second step, for each cell with non-zero weight, a limited number of bonds belonging to the cell are selected and a price weighted portfolio is created. This portfolio matches as closely as possible some of the average characteristics of the cell such as its average duration, convexity etc., and holds appropriate weight in the indexed portfolio.

In case of bonds, the rationing in the number of bonds comes from the explicit limit the indexer imposes while building a bond portfolio for each cell.

  • Optimized Sampling: Optimized sampling overcomes the drawbacks of stratified sampling approach. It has the following advantages.

-

It provides an ex-ante measure of the tracking error of the indexed portfolio with regard to benchmark.

-

It gives access to an optimizer, which facilitates construction of a portfolio by considering the risk trade-off between factors and the transaction costs.

-

It allows the indexer to choose the level of tracking error to be achieved by limiting the number of bonds in the indexed portfolio.


Related Discussions:- Bond indexation

How do risk-averse investors compensate, How do risk-averse investors compe...

How do risk-averse investors compensate for risk when they take on investment projects? For the reason of risk aversion, people demand elevated rates of return for taking on hi

Determine the value of the forward contract, Mr. Lam holds title to an asse...

Mr. Lam holds title to an asset worth €125.72. In order to raise money for an unrelated purpose, he plans to sell the asset in nine months. But Mr. Lam is concerned about the uncer

Mr, discuss the applicability of financial management in respect to poultry...

discuss the applicability of financial management in respect to poultry farming in uganda

Rand corporation, what is the rand corporation five project rank

what is the rand corporation five project rank

gaaps that are mandatory, a) Talk about in brief the various GAAPs that ar...

a) Talk about in brief the various GAAPs that are mandatory to be followed. b) What are the several components of total cost.

Yield to call, Yield to call is the yield that would be realized on a...

Yield to call is the yield that would be realized on a callable bond assuming the issuer of the bond redeems it before maturity. A bond's call provision is detail

Computation of working capital, Will you please define the working capital ...

Will you please define the working capital and Calculation of working capital? I need urgent help in my assignment. help me!

Deefine market price of a bond be influenced, If all other things held cons...

If all other things held constant, how would the market price of a bond be influenced if coupon interest payments were made semiannually in place of annually? Several bonds iss

What are the options available for growth, What are the options available f...

What are the options available for growth Joint venture   A joint venture is when a separate company is formed, in which every member holds an equity st

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd