The Following Information Relates to Questions
Silvia Abram and Walter

question 12

Multiple Choice

The following information relates to Questions
Silvia abram and Walter edgarton are analysts with cefrino investments, which sponsorsthe cefrino Sovereign bond Fund (the Fund) . abram and edgarton recently attended an investment committee meeting where interest rate expectations for the next 12 months were discussed. The Fund's mandate allows its duration to fluctuate ±0.30 per year from the bench- mark duration. The Fund's duration is currently equal to its benchmark. although the Fund is presently invested entirely in annual coupon sovereign bonds, its investment policy also allows investments in mortgage-backed securities (MbS) and call options on government bond fu- tures. The Fund's current holdings of on-the-run bonds are presented in exhibit 1. $\begin{array}{l}\text { EXHIBIT } 1 \text { Cefrino Sovereign Bond Fund Current Fund Holdings of On-the-Run Bonds }\\\begin{array} { l c c c } \hline \text { Maturity } & \text { Coupon/YTM } & \text { Market Value } & \text { Modified Duratio } \\\hline \text { 1-year } & 0.78 \% & \$ 10,000,000 & 0.99 \\\text { 3-year } & 1.40 \% & \$ 10,000,000 & 2.92 \\\text { 5-year } & 1.80 \% & \$ 10,000,000 & 4.74 \\\text { 10-year } & 2.34 \% & \$ 10,000,000 & 8.82 \\\text { 30-year } & 2.95 \% & \$ 10,000,000 & 19.69 \\\text { Portfolio } & 1.85 \% & \$ 50,000,000 & 7.43 \\\hline\end{array}\end{array}$
over the next 12 months, abram expects a stable yield curve; however, edgarton expects
a steepening yield curve, with short-term yields rising by 1.00% and long-term yields rising
by more than 1.00%.
two alternative portfolio scenarios based on her own yield curve outlook:
Scenario 1 Sell all bonds in the Fund except the 2-year and 30-year bonds, and increase
positions in these two bonds while keeping duration neutral to the benchmark.
Scenario 2 construct a condor to benefit from less curvature in the 5-year to 10-year area
of the yield curve. The condor will utilize the same 1-year, 5-year, 10-year, and
30-year bonds held in the Fund. The maximum allowable position in the 30-year
bond in the condor is $17 million, and the bonds must have equal (absolute
value) money duration.
edgarton evaluates the Fund's positions from exhibit 1 along with two of his pro forma
portfolios, which are summarized in exhibit 2: $\begin{array}{l}\text { EXHIB11 } 2 \text { Selected Partial Durations }\\\begin{array} { l c c c c c } \hline \text { Maturity } & \begin{array} { c } \text { Beginning } \\\text { Yield Curve }\end{array} & \begin{array} { c } \text { Curve } \\\text { Shift }\end{array} & \begin{array} { c } \text { Current } \\\text { Portfolio } \\\text { Partial PVBP }\end{array} & \begin{array} { c } \text { Pro Forma } \\\text { Portfolio 1 } \\\text { Partial PVBP }\end{array} & \begin{array} { c } \text { Pro Forma } \\\text { Portfolio 2 } \\\text { Partial PVBI }\end{array} \\\hline \text { 1-year } & 0.78 \% & 1.00 \% & 0.0020 & 0.0018 & 0.0021 \\\text { 3-year } & 1.40 \% & 1.00 \% & 0.0058 & 0.0044 & 0.0061 \\\text { 5-year } & 1.80 \% & 1.25 \% & 0.0095 & 0.0114 & 0.0095 \\\text { 10-year } & 2.34 \% & 1.60 \% & 0.0177 & 0.0212 & 0.0159 \\\text { 30-year } & 2.95 \% & 1.75 \% & 0.0394 & 0.0374 & 0.0394 \\\hline\end{array}\end{array}$ last, edgarton reviews a separate account for cefrino's uS clients that invest in australian
government bonds. he expects a stable australian yield curve over the next 12 months. he
evaluates the return from buying and holding a 1-year australian government bond versus
buying the 2-year australian government bond and selling it in one year. $$\begin{array}{l}\text { EXHIBIT } 3 \text { Cefrino Australian Government Bond Portfolio Assumptions for Stable Yield Curve }\\\\\begin{array} { l c c } & { \quad\quad\quad\quad\text { Portfolio Strategies } } \\& \begin{array} { c } \text { Buy and Hold } \\\text { Portfolio }\end{array} & \begin{array} { c } \text { Ride the Yielc } \\\text { Curve Portfoli }\end{array} \\\hline \text { Investment horizon (years) } & 1.0 & 1.0 \\\text { Bonds maturity at purchase (years) } & 1.0 & 2.0\end{array}\end{array}$$ $$\begin{array} { l c c } \hline & \quad\quad\quad\quad\quad\quad\quad\quad\quad\quad { \text { Portfolio Strategies } } \\ & \begin{array} { c } \text { Buy and Hold } \\\text { Portfolio }\end{array} & \begin{array} { c } \text { Ride the Yield } \\\text { Curve Portfolio }\end{array} \\\hline \text { Coupon rate } & 1.40 \% & 1.75 \% \\\text { Yield to maturity } & 1.65 \% & 1.80 \% \\\text { Current average portfolio bond price } & \mathrm { A } \$ 99.75 & \mathrm {~A} \$ 99.90 \\\text { Expected average bond price in one year for portfolio } & \mathrm { A } \$ 100.00 & \mathrm {~A} \$ 100.10 \\\text { Expected currency gains or losses } & - 0.57 \% & - 0.57 \% \\\hline\end{array}$$ based on her yield curve forecast, abram recommends to her supervisor changes to the
Fund's holdings using the following three strategies:
Strategy 1 Sell the 3-year bonds, and use the proceeds to buy 10-year bonds.
Strategy 2 Sell the 5-year bonds, and use the proceeds to buy 30-year MbS with an
effective duration of 4.75.
Strategy 3 Sell the 10-year bonds, and buy call options on 10-year government bond
futures.
abram's supervisor disagrees with abram's yield curve outlook. The supervisor develops
-based on exhibit 3, the implied australian dollar (a$) 1-year rate, 1-year forward is closest to:

• A) 0.15%.
• B) 1.95%.
• C) 2.10%.

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Definitions:

Standard

A level of quality or attainment used as a measure, norm, or model in comparative evaluations.

Selfish

Prioritizing one's own needs or desires over those of others; acting with concern for oneself above others or the common good.

Rational

Pertaining to reasoning or logical thinking, often involving a systematic process of thinking to arrive at a conclusion.

Ego

In psychoanalytic theory, the part of the personality responsible for dealing with reality, balancing the demands of the id and superego.