April 2011
Beginner
704 pages
21h 44m
English
book
The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition
by Frank J. Fabozzi, Harry M. Markowitz
Content preview from The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition
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QUESTIONS
Answer the questions based on the following information: Consider a portfolio of two equally weighted credit bonds from two different issuers in the same sector. Assume that interest rate risk is modeled by a single variable ΔR, the change of interest rates, and that credit risk in that sector is modeled by another factor ΔS/S, the percentage change of average credit spreads in the sector. Remember this is the DTS factor referred to in the chapter. The loading to this factor is the DTS of the bond. The first bond has interest rate duration D1 = 4yr, spread duration of SD1 = 4.5yr and spread of S1 = 400 bps. The second one has interest rate duration D2 = 6yr, spread duration of SD2 = 6.5yr and spread of S 2 = 100 bps. The volatility of the interest rate factor is σΔR = 30 bps/month, the volatility of the spread factor is σΔS/S = 10%/month, and their correlation is ρ =–30%. The idiosyncratic risk of the securities in this sector is proportional to a parameter. Similar to the systematic spread risk, that parameter measures the average percentage change of idiosyncratic spreads in the sector. The volatility of that parameter is 
= 14% / month. The proportionality factor used to calculate idiosyncratic risk is given by the DTS level of the bond.
= 14% / month. The proportionality factor used to calculate idiosyncratic risk is given by the DTS level of the bond.
1. What is the systematic risk of each security?
2. What is the idiosyncratic risk of each security?
3. Which bond is riskier? ...
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