Reading 27: Fixed-Income Portfolio ManagementPart I－LOS c criteria, investor, specific, justify, income

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CFA Institute Area 8-11, 13: Asset Valuation
Session 8: Management of Passive and Active Fixed Income Portfolios
Reading 27: Fixed-Income Portfolio ManagementPart I
LOS c: Discuss the criteria for selecting a benchmark bond index and justify the selection of a specific index when given a description of an investor's risk aversion, income needs, and liabilities.

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A defined benefit pension plan is most likely to specify its benchmark:

A) as a bond index.

B) in terms of the equity market.

C) in terms of its liability structure.

D) in terms of the Lehman Brothers Aggregate Bond Index.

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Answer and Explanation

The pension plan defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (pension benefits) on its books.

The pension plan defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (pension benefits) on its books.

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Fixed-income investors whose objective is to generate sufficient cash to satisfy their liabilities specify the benchmark:

A) as a bond index.

B) as either a bond index or in terms of its liability structure.

C) in terms of its liability structure.

D) in terms of the convexity of the liability.

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Answer and Explanation

Fixed-income investors whose objective is to generate sufficient cash to satisfy the liabilities specify the benchmark in terms of its liability structure.

Fixed-income investors whose objective is to generate sufficient cash to satisfy the liabilities specify the benchmark in terms of its liability structure.

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Which of the following most accurately describes the relationship between an investor's investment objectives and the benchmark chosen for performance evaluation? An investor with a:

A) liability as a benchmark has an investment strategy to match the timing and amount of the payments corresponding to the liability.

B) bond index as a benchmark has as an investment objective to outperform the bond index.

C) liability as a benchmark has an investment objective that is to earn a higher return than the cost of borrowing.

D) bond index as a benchmark has an investment objective to produce exactly the same cash flows as the bond's underlying the index.

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Answer and Explanation

The purpose of using the liability structure as a benchmark is to ensure meeting the liability payment streams, both in timing and amount.

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What is the investment objective for a pension sponsor who has a defined benefits based liability structure? The main objective is to:

A) minimize prepayment risk.

B) minimize performance risk.

C) match the amount and timing of the liability.

D) outperform a bond index.

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Answer and Explanation

Although the other answers are worthwhile activities in pension fund management, matching the liability structure should be the primary objective for the pension sponsor.

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A commercial bank that borrows and then lends funds is most likely to specify its benchmark:

A) as a bond index.

B) in terms of its liability structure.

C) in terms of the duration of its assets.

D) in terms of the convexity of its assets.

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Answer and Explanation

A commercial bank defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (deposits) on its books.

A commercial bank defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (deposits) on its books.