An Introduction to the Bond Markets

10

Portfolio and Other Considerations

10.1 HOLDING PERIOD RETURNS

A portfolio manager, or for that matter any investor, may want to liquidate a portfolio of bonds at a specified date, the horizon date, in the future. Needless to say, the portfolio manager would like to have a certain amount of confidence in the amount of money that would be received at this date. In achieving this objective, the portfolio manager is presented with several challenges:

• Would any coupons received before the horizon date be able to be reinvested at a satisfactory rate?
• Would the proceeds of any redemption amounts received before the horizon date be able to be reinvested at a satisfactory rate?
• What will be the value of the bond portfolio at the horizon date?
• Would it be possible to redeem any outstanding bonds at a ‘fair’ value? This can sometimes be a problem as the market makers may widen the spreads considerably for all but the most liquid bonds.

The portfolio manager can solve this problem if he or she can find and invest in either zero-coupon bonds or bond strips of suitable quality that yield an appropriate amount and mature on the horizon date. This is because there are no coupons or redemption proceeds to reinvest and, irrespective of movements in interest rates, the value of the portfolio at the horizon date will equal its redemption amounts. Unfortunately, such a satisfactory solution very rarely exists.

Let us now consider the performance of a single bond from now until a horizon date ...