SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

Security Analysis and Portfolio Management

Security Analysis and Portfolio Management

Section A)

Q1) Barbell Strategy

Formula:

(i)The current ('flat', running', 'interest') yield

As UK government bond - 48 Years is a principal STRIP where the payment is made at the end of the maturity date. Like in this case, the payment will be made at the end of 48 years. So there would be not current yield for this bond (Ang, Goetzmann, Schaefer, 2011, pp. 21).

The yield to maturity ('YTM', 'redemption')

And (iv) The duration UK government bond - 10 Years

The duration UK government bond - 2 Years

For the combination of the two bonds purchased, calculate

No duration for UK government bond - 48 Years as there is no interest payment due to the STRIP principal and current yield cannot be calculated without interest rate. Furthermore, as there is no current yield, there would be no duration for this bond purchases.

(c)

There are varieties of strategies which can maximize the bond return. Hence, investors can diversify their bond portfolio through barbell strategy as investors can earn higher returns.

Preservation of capital and Interest: If Investors care for their money and earn interest intact to their goal, consider a strategy of buying and holding.

Maximize Revenue: If investors' goal is to maximize interest income, they usually get better discount long-term bonds.

Management of Interest Rate Risk: Ladders and Bars: Bond investment through barbell, investors manage interest rate risk by creating a laddered portfolio of bonds with different maturities, for example: one, three, five and ten years short term and long term.

Smoothing the Performance of Investments in Shares: Since stock returns are generally more volatile than bonds or equities, combining the two asset classes to help build a portfolio of more general performance stable over time generates.

Saving For a clear goal for the Future: If investors have a child of three years, they first tuition bill may face 15 years from now. Maybe in 22 years, they will have to pay a deposit to their retirement needs, because bonds have a defined period, which can help to ensure that the money is there when needed (Hymas J., 2009, pp. 352).

(d)

Bond convexity measures the interest rate sensitivity of the bond. It determines the curvature between the prince and yield of the bond and reveals duration with respect to changes in interest rate. The convexity is the rate at which the duration changes as we move that is getting away from the point mentioned on the yield curve, is the first derivative of the equation of the duration and the second on the yield curve as mentioned earlier. By convexity we can correct the inaccuracy of the linear behavior of the duration.

Usually the convexity is positive regardless of whether the TIR is rising or not. But, as I mentioned before, at times can become negative, for example when a callable bond approaches the redemption price. Under the redemption price will be positive convexity, but as we approach the redemption price convexity becomes negative ...