The Harvard Management Company and Inflation-Protected Bonds
1(a) Regular Treasury bonds are purchased at face value in the beginning or an adjusted price prior maturity. And in every period, normally annul or semiannual, investor will receive a coupon as an interest and at the maturity a principal plus coupon. (b) Coupon and principal of the Regular Treasury bonds are fixed, therefore if the inflation rate increases in the forecasting future, investor will receive the same amount of coupon and principal with less real value and purchasing power. (c)TIPS are simultaneously related to change of inflation rate which means the principal and coupon will adjust instantly to change of inflation rate. TIPS like Regular Treasury bonds
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3 We can make a hedge portfolio by taking a long position in the inflation indexed TIPS and a short position in the regular bond with the same duration. We know that there are two variables affecting the bonds---real interest rate and actual inflation rate. When nominal interest rate changes, long and short positions of bonds in portfolio offset each other. When inflation rate changes, TIPS would change its price and leave regular bond in short position exposed to inflation risk.
4(a) Harvard’s Policy Portfolio is a portfolio within a group of asset classes including different instruments. It can be used as a benchmark to evaluate the performance of investment strategies. (b) To determine Policy Portfolio by using mean-variance analysis. Given a variable number of expected portfolio return, we would choose our strategy from a set of minimum-variance portfolio basing on our tolerance for risk. (c) Because one of HMS’s goal is to preserving the real value of endowment. Nominal return may reflect much lower real value of endowment because of inflation. So only the real return can make sure that Harvard does not lose money. (d)From exhibit4, domestic equity and foreign equity have a correlation of 0.5. It means there is a relatively big part of portfolios overlaps, which means equity and foreign equity may affect each other due to exposure to risks.
5Yes, TIPS should be considered as an additional asset class in Harvard’s Policy
3. A 2 – year Treasury security currently earns 5.13%. Over the next 2 years, the real
(a) The mean excess return, standard deviation, and portfolio weights for the minimum variance portfolio.
Inflation erodes the purchasing power of a bond 's future cash flows. A rise in inflation will cause investors to demand higher yields to compensate for inflation rate risk. Also, prices will tend to drop because the bond will be paying interest with less purchasing power.
Inflation rate risk, when inflation goes up, the price of the bond usually goes down.
F) Plot the attainable portfolios with Expected return on the y-axis and Risk on the X-axis. Be sure
In order to find the optimal portfolio allocation, the group needs to find the portfolio structured with lowest risk under a given return. This can be achieved by applying Mean-Variance Theory and Markowitz model find the efficient frontier, which yields the most optimal portfolio under given returns. It can be expressed in mathematical terms and solved by quadratic programming. [Appendix A]
B. can take on negative values C. is related to the covariance of a share D. All of the given answers. 11. Portfolio risk is heavily based on: A. a simple average of the variance of the stocks in the portfolio B. a weighted average of the variance of the stocks in the portfolio C. a weighted average of the covariance of the stocks in the portfolio D. the standard deviation of the stocks 12. When an investor alters the mix of their portfolio to reflect market changes, this is called _____ asset allocation A. market timing B. passive
Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for
The Harvard Management Company (HMC) was established in 1974 with the goals providing world-class investment management focused solely on generating strong results to support the educational and research objectives of Harvard University. The company’s goals are to correctly measure Harvard University’s financial requirements and to provide investment opportunities that will accurately meet or exceed them with the lowest amount of risk assumed by the institution.
The value of a bond is found as the present value of interest payments plus
Through this method, we obtained theoretical yields of the 4.25% coupon bond and 10.625% coupon bond to be 2.899% and 2.639% respectively. The corresponding theoretical prices of the bonds are $108.27 for the 4.25% coupon bond and $149.31 for the 10.625% coupon bond (see Table 1 above).
(1) Calculate the expected return (rp), the standard deviation (p), and the coefficient of variation (CVp) for this portfolio and fill in the appropriate blanks in the table.
With Reference to this statement, describe, discuss and illustrate the principles of portfolio theory. Your essay should include coverage of the Markowitz Efficient Frontier and the Capital Market Line.
4. Consider a bond issued at par. The annual coupon is 8 percent and frequency of coupon is semiannual. How would the YTM of this bond be reported in most of the European markets?
The price of the bond with the little coupon will be most affected by changes in interest rates as the price of the great coupon bond. For a small coupon bond, the cash flows are weighted much more towards the maturity due to small interest payments dates. The great coupon bond has high interest