Question

A major requirement in managing a fixed-income portfolio using a contingent immunization policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio. The difference between these values are called “margin of error”. Assume that you are managing a $150 million portfolio with a time horizon of six (6) years. The available market rate at the initiation of the portfolio is 10 percent, but the client is willing to accept 8 percent as the floor rate to allow use of active management strategies. Currently, the market values and current market rates at the end of year 1, 2, and 3 are as follows: (Note: ¹Assume semi-annual compounding interest and coupon payment in your computation. ²Provide final answers in two decimals)

End of year	Market value ($ mil)	Market Yield
1	$155.3	10%
2	$175.5	9%
3	$195.36	7%

(i) Calculate the required ending-wealth value for this portfolio

(ii) Calculate the value of the required floor portfolios at the end of Years 1, 2 and 3.

(iii) Compute the margin of error at the end of Years 1, 2 and 3.

(iv) Explain the next strategy given the situation of each year of investment.

Answer 1

Answer ) As all the calculation is based on semi-annual compounding interest and coupon payment .

Floor rate of return = 8% pa

Margin of error = current market value - required value

end of year	Market value	Market Yield	ending-wealth value($Mil)	required floor portfolios ($Mil)	margin of error(($Mil)	strategy
	($ mil)
1	$155.30	10%	$171.22	$167.97	$3.25	Should continue to with same portfolio , and/or can switch some portion in less return giving assets for safety
2	$175.50	9%	$191.65	$189.82	$1.83	Should continue to with same portfolio , the return is less than last year
3	$195.36	7%	$209.27	$211.30	($2.03)	Should consider to reinvestment in new assets with higher return with more calculation