Return enhancement on investment, Financial Management

Assignment Help:

Return Enhancement can be explained using following heads:

  • Use of a Valuation Model: An investor having access to a bond valuation model can build a bond portfolio from bonds that are designated as mispriced on the low side by the model. A significant point here is - the nature of a bond valuation model is much more technical compared to equities. Further, fungibility or interchangeability between bonds in terms of their risk characteristics is more than that found in equities. In other words, the switches in between bonds that may be suggested by a valuation model have more true arbitrage characteristics than the switches among equities.

  • Options Overwriting: A portfolio manager can enhance the returns of a bond portfolio through options overwriting, which means writing interest rate related calls or puts. The forecast for bonds depends on the timing of long-term interest rates.

  • Minimization of the Value of the Bond Portfolio: The portfolio manager can minimize the value of the bond portfolio while implementing liability funding methods. For example, let us discuss the return enhancement technique while immunizing a single liability. Suppose the problem of the portfolio manager is

                   2417_return enhancement.png

The two constraints the portfolio manager experiences are:

                205_return enhancement1.png

In the above equations Pi denotes price of bond i.

The first constraint results in an asset portfolio composed of only bonds. The second constraint causes the duration of the bond portfolio to match the duration of the liability. This technique of optimization is popularly known as linear programming. Such a problem can be solved in a simple way by using well established algorithms. The portfolio manager has to make sure whether the internal rate of return of the bond portfolio thus constructed is more or less similar to the rate he has used to discount the present value of the liability. If not, the portfolio manager in order to discount the liability must optimize again using the internal rate of return of the earlier optimal portfolio.

An important point here is the choice of the set of bonds over which the optimization will take place. Such set must be homogeneous in terms of quality rating. Otherwise, the optimized portfolio will concentrate just on those bonds that result in higher yields as they are cheap and does not consider their risky nature.


Related Discussions:- Return enhancement on investment

Performance of mutual funds, Performance of Mutual Funds The performanc...

Performance of Mutual Funds The performance of Mutual Funds can be evaluated by calculating the rate of return earned during the relevant comparison period. The return will inc

Capitalization ratios, Capitalization ratios are used for determining the e...

Capitalization ratios are used for determining the extent to which the corporation is trading on its equity, and the resulting financial leverage. These ratios

Please help me solve this question, there are 3 compaies i have to find out...

there are 3 compaies i have to find out the price of equity share by using walters and gordons model.

Walter''s model, 3. The following information are related to Sun Ltd. Paid...

3. The following information are related to Sun Ltd. Paid-up equity capital ` 10,00,000 Earnings of the company ` 1,00,000 Dividend paid ` 80,000 Price - Earning rat

Explain the cash and cash equivalents, Explain the Cash and cash equivalent...

Explain the Cash and cash equivalents Cash and cash equivalents include: Bank and cash balances Short term investments that are highly liquid and can be converted

Commodities exchange, Explain the organization and function of commodities...

Explain the organization and function of commodities exchange

Determine finance growth and evolution, a) Debentures are a source of exter...

a) Debentures are a source of external long term (loan) finance for which interest is paid to the debenture holder. Debenture holders do not usually have voting or ownership rights

Baumol model, A campany estimate a cash requirment of 900000 the opportunit...

A campany estimate a cash requirment of 900000 the opportunity interst eate is 9% per anual the transaction cost for borrowing or withdrawing fund is 264.5

Debenture, Debenture A kind of debt instrument that is not secured by p...

Debenture A kind of debt instrument that is not secured by physical any asset or collateral is known as debenture. Debentures are backed by the general creditworthiness and sta

., give and explain the seven sources of finance

give and explain the seven sources of finance

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