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BOND MATH: The Theory Behind the Formulas by Donald J. Smith

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An Interest Rate Swap Overlay Strategy

Bond portfolios residing on either the asset or liability side of the balance sheet can be restructured internally or externally. I think of internal risk management as rebalancing via bond purchases and sales, for instance, as above, changing the average duration or convexity of the portfolio to conform to a particular rate view. The idea of “internal” is that the transactions are routine for the portfolio manager—buying and selling bonds. Often, external risk management accomplishes the same end. “External” here means using derivatives to transform some particular aspect of the asset or liability portfolio (i.e., its currency mix, credit exposure, or interest rate risk statistics). These are called derivatives ...

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