LOS n: Differentiate between the effect of the interest rate environment and the effect of active management on fixed-income portfolio returns.

Q1. The following are a number of contributions to return for a fixed-income portfolio:

1. Return on interest rate management

2. Return on trading activity

3. Return due to changes in forward rates

4. Return on the default-free benchmark

Which of the above statements are TRUE?

Effect of External Interest Environment        Contribution of the Management Process

A)      1, 3                                                                                  2, 4

B)      3, 4                                                                                  1, 2

C)      3                                                                                       1, 2, 4

Q2. Which of the following statements in relation to the effect of the external interest environment is FALSE?

A)   Return on the default-free benchmark assumes no change in the forward rates.

B)   The return due to the external interest rate environment is estimated from a term structure analysis of AAA rate corporate securities.

C)   The overall effect represents the performance of a passive, default free bond portfolio.

LOS n: Differentiate between the effect of the interest rate environment and the effect of active management on fixed-income portfolio returns. fficeffice" />

Q1. The following are a number of contributions to return for a fixed-income portfolio:

1. Return on interest rate management

2. Return on trading activity

3. Return due to changes in forward rates

4. Return on the default-free benchmark

Which of the above statements are TRUE?

Effect of External Interest Environment        Contribution of the Management Process

A)      1, 3                                                                                  2, 4

B)      3, 4                                                                                  1, 2

C)      3                                                                                       1, 2, 4

Correct answer is B)

Changes in forward rates and the return on the default free benchmark are outside of the manager’s influence and are therefore part of the external interest environment. Interest rate management and trading activity are an integral part of the role of the manager and are therefore part of the management process. Remember we could also include return from sector/quality management and return from the selection of specific securities.

Q2. Which of the following statements in relation to the effect of the external interest environment is FALSE?

A)   Return on the default-free benchmark assumes no change in the forward rates.

B)   The return due to the external interest rate environment is estimated from a term structure analysis of AAA rate corporate securities.

C)   The overall effect represents the performance of a passive, default free bond portfolio.

Correct answer is B)

The return due to the external interest rate environment is estimated from a term structure analysis of Treasury securities. We are trying to establish the return on a default free bond portfolio, therefore the use of corporate securities would be inappropriate.

Thanks.