Fixed Income - A or E = Bond Portfolio?

CFA Level III Fixed Income
#1

On page 109 of the fixed income text, 2nd paragraph it says --> suppose the $140 bond portfolio (A=$140M) has…

In the 2012 exam it says --> Janet brown manages a 200million US dollar portfolio of government bonds. Here, E = $200M.

The bond portfolio is A=140M in the text and E=200M on the exam. On the exam, I would’ve used A =200M and got it wrong.

Whats the difference? What am I missing?

Much appreciated.

#2

As per textbook, A = 140m = 100m + 40m = value of bond portfolio + value of equity portfolio

Perhaps CFAI poorly phrased it, when it should have said: “suppose the $140 ‘overall’ portfolio (A=$140M) has…”

So, as per the 2012 exam (which I dont have at the moment), you should also add value of equity portfolio to your formula.

#3

For 2012 the 200M is the equity. That’s where I’m confused. I would’ve had that 200M as Assets and how it was done in the text. I’m not liking the wording and I dont want to make a mistake like this when I know how to do the stuff.

Thanks,

#4

Got both parts on first try. Possibly u’ve got your formulas wrong.

Try the below formulas:

#1####

% return on levered portfolio = % return on unlevered portfolio + (Debt-to-equity ratio)(% return on unlevered portfolio - Interest rate on borrowings)

Where Debt-to-equity ratio = Amount borrowed / Amount of equity

4.4%=3.2%+D/E ratio (3.2%-2.4%)

Equity (Government bonds)=200m, Solve for Debt (Amount borrowed): 300m

#2####

Duration of levered equity = [(Duration of unlevered portfolio * Value of invested portfolio at start)-(Duration of borrowings * Amount borrowed)] / Amount of equity

Where Value of invested portfolio at start = Amount borrowed + Amount of equity at start

Duration of levered equity = [(8.5*500m) - (0.8*300m)] / 200m = 20.05

#5

I understand how to do the questions. It’s something subtle.

Notice in your second comment, you wrote:

As per textbook, A = 140m = 100m + 40m = value of bond portfolio + value of equity portfolio

Even you put 100M for the value of the bond portfolio. In the text on page 109, it says bond portfolio = 140M.

This is the only point where my confusion lies. If it was exam day, I would’ve used the 200M governement bonds = Assets and Not to Equity because of how the textbook wrote it.

Textbook said bond portfolio = 140M = Assets. Exam question used bond portfolio = E = 200M.

Thanks,

#6

Im making this tougher than it is. I’m assuming it’s just in the context of the numbers given on page 109. I dont like how they used Bond portfolio to mean Assets in the text and then as Equity on the exam.

In the context of the givens, they named it bond portfolio but it’s really E + L.

#7

This is a reading comprehension issue -

Example 9:

Manager has $40m of funds to invest and borrows $100m - He invests EVERYTHING in bonds so it is a bond portfolio. The equity only has to do with the dollars he owns not borrowed. This question is about leverage and not about Bonds vs Equities such as stocks.

So what are you missing - You are missing that in Example 9 - the PM has 40m of equity in a 140m bond portfolio - the delta is borrowed. On the 2012 exam - $200m is equity and you need to calculate the amount of borrowing the PM needs to achieve the desired return.

#8

Pirates

Great. I got that after but great explanation. Much appreciated.

#9

No worries mate - good luck in June!