gioa workshop effective agency strategies l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
GIOA Workshop : Effective Agency Strategies PowerPoint Presentation
Download Presentation
GIOA Workshop : Effective Agency Strategies

Loading in 2 Seconds...

play fullscreen
1 / 29

GIOA Workshop : Effective Agency Strategies - PowerPoint PPT Presentation


  • 217 Views
  • Uploaded on

GIOA Workshop : Effective Agency Strategies. Stephen Manning, CFA Director – Institutional Branch Services. March 16, 2011. Developing Portfolio Strategies Using Agencies. Risk Management Overview The Portfolio Process A Brief discussion on Duration and Convexity

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'GIOA Workshop : Effective Agency Strategies' - Olivia


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
gioa workshop effective agency strategies

GIOA Workshop : Effective Agency Strategies

Stephen Manning, CFA

Director – Institutional Branch Services

March 16, 2011

developing portfolio strategies using agencies
Developing Portfolio Strategies Using Agencies
  • Risk Management Overview
    • The Portfolio Process
    • A Brief discussion on Duration and Convexity
  • Agency Alternatives:
    • Agency Bullets
    • Fixed Coupon Callables
    • Step Ups
    • Fixed to Float
  • The Cost of “Waiting”
  • Useful Bloomberg Tools
investment decision process

SAFETY

LIQUIDITY

Investment Policy / Guidelines

Interest Rate

Social Screens

Risk

Macroeconomic

Yield Curve

Trends

Risk

Implement

Market

Cash Flow

Portfolio Strategy

Trends

Risk

Credit

Credit Risk

Trends

Liquidity Risk

Investment Decision Process
quantifying risk

Interest Rate

Effective Duration – Expected Change in Price For every 100bp Shift in Rates

Convexity – How will my duration Change as yields change.

Risk

Yield Curve

Risk

Partial Durations – Shift a Single Point on the curve to Determine Where on the curve your risk exposure is concentrated.

Cash Flow

Risk

Cash Flow Simulation – Run Cash flows across multiple horizon rate scenarios to ensure there are no liquidity gaps

Quantifying Risk
duration
Duration

Duration is the slope of a line drawn tangent to the price-yield curve and shows the % change in bond price for a given change in yield.

  • Duration – Expected %Change in Price For a 100bp Shift in Rates
  • Graphically - The Slope of the Price Yield Function

Bond Price

Yield

duration7
Duration
  • Example: the price of a bond with a duration of 3.0 is expected to:
    • Fall by 3% when rates rise by 100bp
    • Increase by 3% when rates fall (rally) 100bp.
  • However: The price/yield relationship is rarely linear (a straight line).

Bond Price

Out Performance

Yield

convexity
Convexity
  • Convexity – Expected Change in Duration For a 100bp Shift in Rates
  • Positive Convexity - When rates change, the bond outperforms the duration.
  • Negative Convexity – When rates rally, the bond will underperform its duration.

Bond Price

*P

Bond A

**P

**P

Bond B

Duration

**Y

*Y

Yield

**Y

Bond Price

*P

*Y

Yield

bullets no optionality

Ticker

Yield

Spread to TSY

Bullets: No Optionality
  • Key Features:
    • Fixed Coupon throughout life
    • Certainty of Cash Flow
    • Start with HIGHER Duration than callable.
    • LOWER Yield/Coupon than callable.
    • Slight Positive Convexity
    • Best Performer when rates moving lower (Bullish).
    • Better Liquidity
  • Bloomberg: FIT <GO>
    • Update Market to “Agency” if not the default.
finding carry callable agencies
Finding Carry: Callable Agencies
  • Fixed Coupon Callables
  • 1X Call (Euro):
    • Higher Coupons than Bullets, and initial Step-Up Coupons.
    • 1x Calls become bullet alternatives if not called on the call date.
  • Berm and Cont. Call:
    • Higher Coupon than 1x Call (Selling more optionality).
    • Better Convexity Profile.
    • Duration does not extend as quickly as 1x call, as the “next call” keeps it shorter.
finding carry defensive step ups
Finding Carry: Defensive Step-Ups
  • Synthetic Premiums
    • One time step-up, with above market back end coupon.
    • Increases the probability the bonds will get called, even with rates higher.
    • 1X Call, with in-the-money back coupon.
      • Give up some income on the front coupon
      • Higher probability of call
      • Price yield off the Maturity, while synthetically keeping your duration much shorter.
      • 5NC2 Example?
    • Multi-Step Multi Call
finding carry defensive step ups13
Finding Carry: Defensive Step-Ups
  • Defensive Multi-Step Structures
    • Starting coupons significantly higher than short cash rates to the first call
    • Coupons set to step up in line with future expectations in rates, to improve price performance, and keep durations short in rising rate environment.
defensive strategies
Defensive Strategies
  • Fixed To Float
    • ABOVE Market Initial Coupon – Increase Cash Flow
    • Below market spread on back end floater, but with frequent resets, bond remains near par in back up.
    • Take on “Basis Risk” of spread widening, which should be much lower than the pure duration risk of a fixed coupon bond.
discount callables
Discount Callables
  • Euro Calls (1X)
    • Viewed as Bullet Alternatives
    • Depending on strike, call date, many already extended in their durations.
    • Look for Yield Pick-Ups to Bullets
  • Bermuda / Continuous Calls
    • Steep Yield Curve / Roll Down means some of the forward call options are still in the money despite discount price.
    • Look for Pick Up to bullets.
    • Many trading to the expected call date, as opposed to the maturity, which can make them look rich optically.
    • Look for opportunities to pick up yield to Maturity, with excellent upside if the market does not back up more, and the bonds are called early.
buy and hold carry still important
Buy and Hold – Carry Still Important
  • With the steep yield curve, look for Carry and Roll down.
    • Callable agencies such as the one above offer significant pick up to cash, while taking on moderate duration risk.
    • Over a 1 year time period, the Callable Agency outperforms the theoretical cash pool even in a +100bp rate shift.
    • If it takes 2 years to sell off, this Callable outperformed even through the +200bp scenario.
    • Callable Agencies represent a good sector to pick up yield, and reduce duration vs. similar maturity bullets in the agency and credit markets.
    • Always Keep your Liquidity Needs in mind, and evaluate the full extension risk of callables.
income break even
Income Break Even
  • Break Even Income Analysis After 1 Year
    • The above callable agency generates 840k in interest over 4 yrs
    • Starting with a cash rate of 23bp for 1 year (1yr Tsy) you would need to reinvest at a rate of 2.72% to break even.
    • Implies a back up of 94bp in Treasuries to attain that.
    • 3YR Treasury Rate, 1YR Forward is currently 2.21%, implying just a 100bp Backup over the next year.
new issue monitor nim2
New Issue Monitor: NIM2
  • NIM2 <GO>
    • Shows all the announced new issue deals, and upsizes in the market.
    • Ordered by date, and time, newest to oldest
option adjusted spreads oas1
Option Adjusted Spreads (OAS1)
  • OAS is an Extremely useful pricing tool
    • “Spread” to the CURVE after taking out the value of optionality.
    • CUSIP Govt OAS1 <GO>
      • Spread to Treasury Curve (I111).
      • 14 Vol is standard for street pricing, but does not reveal value.
aoas screen relative value
AOAS Screen – Relative Value
  • “A”OAS – Spread to the Agency Curve
    • CUSIP Govt AOAS <GO>
    • Spread to Relevent Agency Benchmark Curve, with Live Volatility
      • Spread to Treasury Curve (I111).
      • 14 Vol is standard for street pricing, but does not reveal value.
forward rates
Forward Rates
  • FWCM <Go>
    • Can look at US Treasury and Swap Forward Rates
forward rates24
Forward Rates
  • FWCV <GO>
    • Forward curve for agency bullets is projecting higher yields
forward rates series
Forward Rates - Series
  • FWCV <GO> ; 3 <GO>
    • Useful to see the path of single rate forward in time.
disclaimer
Disclaimer

Conflicts Disclosure: RBC Wealth Management’s Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request and is also made available on our website at http://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?EntityID=2. We reserve the right to amend or supplement this policy at any time. For the current policy, please check our website.

The author(s) is/are employed by RBC Wealth Management, a division of RBC Capital Markets, LLC, a securities broker-dealer with principal offices located in Minnesota and New York, USA.

Disclaimer

The information contained in this report has been compiled by RBC Wealth Management from sources believed to be reliable, but no representation or warranty, express or implied, is made by Royal Bank of Canada, RBC Wealth Management, its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this report constitute RBC Wealth Management’s judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice. This material is prepared for general circulation to clients, including clients who are affiliates of RBC Wealth Management, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither RBC Wealth Management nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Wealth Management. RBC Wealth Management is a division of RBC Capital Markets, LLC, which is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Additional information is available upon request. Copyright © 2011 by RBC Capital Markets, LLC. Member NYSE/FINRA/SIPC. All rights reserved