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Type of Portfolio Strategies Basic Strategies Passive/Active Strategies How Bond Price Change How to Predict Key Variables.

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Presentation on theme: "Type of Portfolio Strategies Basic Strategies Passive/Active Strategies How Bond Price Change How to Predict Key Variables."— Presentation transcript:

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3 Type of Portfolio Strategies Basic Strategies Passive/Active Strategies How Bond Price Change How to Predict Key Variables

4 Coupon Maturity Yield Yield Curve High / Low Long / Short Parallel / Flatten Steepen / Hump Pattern Impact to Bond Price

5 Liability Funding Approach Based on Funded Liability Unified Approach Based on Risk Disaggregate Total Return Approach Based on Risk Factors

6 Risk ExposureType of BetForecast Scenario Steepen, Flatten Slope Bull, Bear Market Direction Curve Bull / Bear Steepener Duration Direction + Slope Combination

7 Widen, Narrow Bull / Bear Flattener High, Low Direction + Slope Combination Country / Credit Spread Convexity Volatility Risk ExposureType of BetForecast Scenario

8 Follow Trend Curve Duration Combination Flattener Spread Volatility Steepener Combination Try to Forecast Trend Risk Exposure Directional Strategies Relative Value Strategies

9 Immunization Strategy Dedicated Portfolio Strategy Duration & Liability Matching Cash Flow & Liability Matching Note : Immunization based on parallel shift of yield curve assumption but it is not parallel shift in real world. To cope this, M-square / M – vector are the answer.

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11 5 1 2 3 4 5 Time Duration 4 3 2 1 Note : Instead of periodical port rebalancing, fund manager can use bond derivative to adjust port duration.

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13 100 1 2 3 4 5 Time Obligation

14 1 5 10 15 Payout Year Cash MatchedDuration Matched

15 Required Assets 10 15 20 60 80 100 120 140 Yield ( % ) Bt.’ Million 15% Market Rate 14% Market Rate Trigger Point Condition of Immunization : 1) Market value of assets must be greater than / equal to pv of the liabilities 2) the dispersion of assets ( degree of barbelling ) must be greater than / equal to the dispersion of liabilities. Modern Immunization Strategies includes M – Square Model and M – Vector Model which cover risk from non-parallel shift of yield curve.

16 Total Return = Total Return of Market + Return Added Through Bond Selection = Beta + Alpha Beta Portfolio Alpha Portfolio

17 Futures Contracts On an Index Options on an Index Swaps on an Index

18 Equity Portfolio Index Future Bond Indexing Bond Portfolio Equity Indexing Bond Future

19 Life Insurance / Pension Fund Life Insurance / Pension Fund Structure / ALM Income Focus on Yield Commercial Bank Commercial Bank Structure / ALM Positive Spread bet. Lending & Financing Positive Spread bet. Lending & Financing Hedge Fund / Traders Hedge Fund / Traders Active Absolute, Total Return Focus on Capital Gain Absolute, Total Return Focus on Capital Gain Mutual Fund ( Some) Passive Relative Return / Benchmark L/T S/T No Investor Type Portfolio Strategy Return Objective Curve Bias

20 Basic Trade For more risk-neutral Investors Conservative Trade For more risk-averse Investors Aggressive Trade For more risk-Seeking Investors

21 Conservative Trade Cash Neutral Earn Cash Duration Shorten Cash-Duration Neutral Duration Neutral Duration Extension Withdraw / Borrowing Basic Trade Aggressive Trade

22 Interest Payment ( Coupon Income ) Reinvestment Income Reinvestment of Coupon Income Capital Gain Gain/Loss from Bond Price Change

23 Roll Down Return Carry Roll down refer to capital gain associated with a falling yield that is typical of a bond approach maturity. Roll down refer to capital gain associated with a falling yield that is typical of a bond approach maturity. Carry is the net financing cost of trade or different between coupon earn & interest paid to finance position ( coupon – repo ) Carry is the net financing cost of trade or different between coupon earn & interest paid to finance position ( coupon – repo ) i i Maturity Short termMedium term Long term Carry = Coupon – Repo Rate - 0.5 = 2.5 – 3.0 + 2.5 = 5.5 – 3.0 STLT

24 Coupon Roll-down Convexity Duration Rich / Cheap Carry Credit, Inflation Yield Curve Risk Volatility Risk Market Risk Yield Curve / Liquidity Risk LT Bond Depend on MK Depend on Mispricing Depend on Trade Financing LT Bond Source of Return Return Relationship Sources of Risk

25 i i Maturity Short term Medium term Long term Interest rates are expected to fall Invest long term Interest rates are expected to rise Invest short term Bullet

26 i i Maturity Short term Medium term Long term Interest rates are not clear Invest both Long term and Short term Barbell

27 i i Maturity Short term Medium term Long term Interest rates are not clear Invest in All Maturity Short / Medium / Long Ladder

28 i i Maturity Short term Medium term Long term Interest rates are not clear Invest in All Maturity Short / Medium / Long Ladder

29 i i Maturity Short term Medium term Long term S / T & L/T Interest Rates Short M/T Bullet are expected to fall but M/T and Long Barbell Rates are expected to rise Butterfly

30 i i Maturity Short term Medium term Long term ST Yield Curve steepen Invest in 2-3 years & Interest Rate is not Clear Instead of 1 year. Riding Down the Yield Curve

31 i i Maturity Short term Medium term Long term Anticipated parallel shift in the yield curve. Short en Duration Extend Duration Interest rates expected to fall Extend Duration Interest rates expected to rise Shorten Duration Assumption Profit : interest rates, positive carry,roll ( curve flatten & volatility ) Loss : interest rates, ( enough to offset carry and roll )

32 Selling or Buying Bond Using Interest Rate Swaps Buying / Selling Interest Rate Futures

33 Investor expects the BOT at its next policy meeting to cut interest rate. The investor believe s that the shape of the yield curve will remain the same. The investor is cash constrained in that purchased must be financed by sales of other assets. Short term Bond 1 – 2 Year Bond Long term Bond 10 Year Bond Sell 1 Unit Buy 1 Unit The Basic Strategy Cash Neutral Duration Extension Then Cash Neutral Duration Extension 1 – 2 Year Bond 15 Year Bond Sell Short term Bond Then Buy Long term Bond 1 Unit 1.5 Unit Aggressive Trade Borrowing Cash Neutral Duration Extension 1 – 2 Year Bond 7 Year Bond Sell Short term Bond Then Buy Long term Bond 1 Unit Cash Neutral Conservative Trade

34 Anticipated changes in the slope of yield curve. i i Maturity Short term Medium term Long term Neutral Duration, Sell Long, Buy Short Yield curve expected to steepen Neutral Duration / Sell Long, Buy Short Yield curve expected to flatten Neutral Duration / Sell Short, Buy Long Neutral Duration, Sell Short, Buy Long May have to draw down cash B/L or borrowing & has potential for negative carry Profit : significant curve steepening ( also volatility ) Loss : curve flattening, possible negative carry, roll disadvantage Profit : curve flattening, possible positive carry, roll advantage ( also volatility Loss : curve steepening May have benefit from roll-up advantage & has potential for positive carry Assumption

35 Anticipated changes in the slope of yield curve. i i Maturity Short term Medium term Long term Neutral Duration, Sell Long, Buy Short Yield curve expected to steepen Neutral Duration / Sell Long, Buy Short Yield curve expected to flatten Neutral Duration / Sell Short, Buy Long Neutral Duration, Sell Short, Buy Long May have to draw down cash B/L or borrowing & has potential for negative carry Profit : significant curve steepening ( also volatility ) Loss : curve flattening, possible negative carry, roll disadvantage Profit : curve flattening, possible positive carry, roll advantage ( also volatility Loss : curve steepening May have benefit from roll-up advantage & has potential for positive carry Assumption

36 Investor expects the ThaiBMA yield curve will steepen over the investment horizon, with no overall bias on whether market direction will be up or down. Short term Bond 2 Year Bond Long term Bond 10 Year Bond Sell 1 Unit Buy 1.35 Unit Then Draw Cash Duration Neutral Steepener The Basic Strategy Sell Long term Bond Then Buy Short term Bond 7 Year Bond 2 Year Bond 1 Unit 1.15 Unit Draw Cash Duration Neutral Steepener Conservative Trade Sell Short term Bond Then Buy Draw Cash / Borrowing Sell Long term Bond Then Buy 15 Year Bond 2 Year Bond 1 Unit 1.35 Unit Borrowing Short term Bond Duration Neutral Steepener Aggressive Trade

37 Investor expects the ThaiBMA yield curve will flatten over the investment horizon, with no overall bias on whether market direction will be up or down. Short term Bond 2 Year Bond Long term Bond 10 Year Bond Sell 1 Unit Buy 1.0 Unit Then Cash Neutral Cash-Duration Neutral Flattener The Basic Strategy Sell Short term Bond Then Buy Long term Bond 2 Year Bond 1 Unit 0.65 Unit Earn Cash 7 Year Bond Duration Neutral Flattener Conservative Trade Duration Neutral Flattener Sell Short term Bond Then Buy Draw Cash / Borrowing Sell Short term Bond Then Buy 2 Year Bond 15 Year Bond 1 Unit 1.35 Unit Long term Bond Borrowing Aggressive Trade

38 i i Maturity Short term Medium term Long term Anticipated changes in the slope of yield curve. Bear Steepener Shorten Duration, Sell Long, Buy Short Yield curve expected to bear steepen Shorten Duration / Sell Long, Buy Short Yield curve expected to bull steepen Extend Duration / Sell Short, Buy Long Bull Steepener Extend Duration, Sell Short, Buy Long May have to draw down cash B/L or borrowing & has potential for negative carry May not to draw down cash B/L or borrowing & has potential for positive carry Profit : significant curve steepening ( also volatility ) Loss : curve flattening, possible negative carry, roll disadvantage Assumption

39 i i Maturity Short term Medium term Long term Anticipated changes in the slope of yield curve. Bear Flattener Shorten Duration, Sell Long, Buy Short Yield curve expected to bear flatten Shorten Duration / Sell Long, Buy Short Yield curve expected to bull flatten Extend Duration / Sell Short, Buy Long Bull Flattener Extend Duration, Sell Short, Buy Long May have to draw down cash B/L or borrowing & has potential for negative carry May have benefit from roll-up advantage & has potential for positive carry Assumption Profit : curve flattening, possible positive carry, roll advantage ( also volatility Loss : curve steepening

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41 Short LT & Long ST Steepener Bull Bear Duration Short ST & Long LT Flattener Neutral Strategy

42 Maturity Short term Medium term Long term i i 2 2 5 5 10 B B Anticipated non-uniform changes in the slope of yield curve. Yield curve expected to be rising using duration-neutral butterfly by short humped barbell & long a duration match bullet. A A Duration-neutral butterfly, sell barbell, long bullet of intermediate bond. Assumption Profit : curvature, ( also volatility ) Loss : curvature, negative carry, roll disadvantage

43 Investor expects the ThaiBMA yield curve will shift temporarily from normal shape to concave or humped shape. Specifically, 5 year bond looks cheaper than 2 and 10 years bond. Barbell 2 & 10 Year Bonds Bullet 5 Year Bond Sell 1 Unit Buy 1.0 Unit Duration-neutral Butterfly Then Earn Cash The Basic Strategy Sell Then Buy 1 Unit 2.0 Unit Cash neutral Barbell 2 & 20 Year Bonds Bullet 5 Year Bond Cash-neutral Butterfly Conservative Trade Sell Then Buy Bullet 5 Year Bond Barbell 2 & 10 Year Bond 1 Unit 2.0 Unit Cash-neutral Butterfly Cash neutral Aggressive Trade

44 Maturity Short term Medium term Long term i i 1 1 5 5 10 B B Anticipated non-uniform changes in the slope of yield curve. Yield curve expected to be falling using duration-neutral butterfly by short humped bullet & long a duration match barbell. A A Duration-neutral butterfly, sell bullet of intermediate, long barbell bond. Assumption Profit : curvature, carry, roll ( also volatility ) Loss : Curvature

45 Investor expects the ThaiBMA yield curve will shift temporarily from normal shape to reverse concave or humped shape. Specifically, 5 year bond looks rich than 1 and 10 years bond. Barbell 1 & 10 Year Bonds Sell 1 Unit Buy 1.0 Unit Duration-neutral Butterfly Then Cash withdraw The Basic Strategy 5 Year Bond Bullet

46 Type of Spread Bets Individual Securities Spread Industry Spread Bond Market Spread Individual Securities Spread Industry Spread Bond Market Spread Rotation / change to new bond Sector Rotation Market Rotation Rotation / change to new bond Sector Rotation Market Rotation Type of Spread Spread narrowing trade Position Structure Weight Matching Long Spread prod. +100% Cash, duration Short Benchmark - 100% Cash, duration Spread widening trade Position Structure Weight Matching Long Benchmark +100% Cash, duration Short Spread prod. - 100% Cash, duration Profit : Narrowing credit spreads, positive carry Loss : Widening credit spreads Spread narrowing trade Profit : Widening credit spreads Spread widening trade Loss : Narrowing credit spreads

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48 Investor expects the spread between corporate and government bond yield to narrow as a result of an overall economic recovery. Government Bond 10 Year Bonds Corporate Bond 10 Year Bond Sell 1 Unit Buy 1.0 Unit Cash / Duration-neutral Then Cash neutral The Basic Strategy Sell Then Buy Corporate Bond 10 Year Bond Government Bond 10 Year Bond 1 Unit 1.5 Unit Cash / Duration-neutral Cash withdraw Aggressive Trade Sell Then Buy 1 Unit 1.0 Unit Cash neutral Government Bond 10 Year Bonds State-own Bond 10 Year Bond Cash / Duration-neutral Conservative Trade

49 Derivatives Via Swaps / Options Credit Spread Trade Bond with Embeded Option Straight Bond By Convexity Selection How to Bets ?

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51 Trade Buy Volatility Sell Volatility Long Straddle Straight Bond Long term Bond Short term Bond Bond with Option Long Bond with Put Long Bond with Call Options Short Straddle How to Bets ?

52 Short-end Intermediate Long-end OR Straight Bond - 100% +52% - 100% + 48% + 100% How to Bets ?

53 Market Neutral Arbitrage bt. Similar Bond Arbitrage along Yield Curve Arbitrage bt. Cash & Futures Convertible Arbitrage TED Spread Trade

54 Non Market Neutral Credit Arbitrage Other Spread Trading Yield Curve Arbitrage

55 Momentum Reactive Strategies Duration-based Mean Reversion

56 Buy and hold Strategy –Easy to adjust port with buy / sell –We can call as Modified Buy and Hold Strategy Indexing –Invest based on selected bond index –Port performance depends on tracking error during bond selection process Buy and hold Strategy –Easy to adjust port with buy / sell –We can call as Modified Buy and Hold Strategy Indexing –Invest based on selected bond index –Port performance depends on tracking error during bond selection process Stratified Sampling Approach Optimization Variance Minimization Stratified Sampling Approach Optimization Variance Minimization Short falls of MPT : 1) Risk is symmetry bt. upside & downside risk. 2) Return is average return not minimum acceptable return ( MAR ).

57 Bond Price Fundamentals Technical Factors Wildcards Sentiment

58 Seasonal Factors Economic Fundamentals Political Business Cycle Central Bank Status / Policy Technical Analysis Flow Transient Supply/Demand Demographics Interest Rate

59 Market Time Horizon Market Context Bias Economic Fundamentals L / T Deep, orderly & Efficient Markets Price = Fundamentals only Political Business Cycles M / T & L / T Disorderly & Inefficient Markets Growth during election, ; Inflation afterward Multiple Central Bank Targets M / T & L / T All Inflation if have growth And employment targets Central Bank Independence M / T & L / T All More Inflation if less Independent Demography L / T All Depends on Spending & Saving of Population Technical Analysis S / T Trending, Inefficient & Volatile Forecasts in S/T Extend Trend in L/T Orderly Markets Flow S / T Thin or Small Market None Transient Supply & Demand S / T Thin or Small Market None Seasonal Factors S / T Thin or Small Market Historical Bias

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