Investment Theory and Risk Management, + Website

A Bond Portfolio Strategy (Optional)

Bond managers typically make yield curve bets based on their perceptions of general movements in the yield curve over the portfolio-holding period (Peterson and Gardiner 2006). Portfolios are typically formed on the basis of these expectations and rebalanced monthly to reflect both changes in realized yields as well as expectations revisions.

At the beginning of each quarter, we construct a bond portfolio (the active portfolio) consisting of 2-year, 5-year, 10-year, and 30-year Treasury securities reflecting a yield curve bet based on current one-step ahead forecasts at each of these four points on the yield curve. The so-called benchmark portfolio is also constructed from the same four Treasury securities. Our desire is that the active portfolio adds value over the benchmark portfolio (see Chapter 10 on active management for a deeper explanation). Our strategy is this: if the current quarter yield is forecasted to fall (rise) relative to the last observed yield for a specific on-the-run (OTR) security, then the portfolio takes a long (short) position in that bond.

Each bond's weight in the portfolio is a function of relative yield curve duration (using the beginning of month [BOM] durations) and BOM market value of the OTR bonds. Appropriate OTR securities for each month were obtained through Lehman Brothers along with relevant information for each security, such as month-end price, yield, modified duration, and total return. Citigroup provided ...