Write analytical report on Greydanus, Broekh and Associates (GBA)’s portfolio management style. In the report, you need to
• assess GBA’s performance,
• comment on their investment strategy,
• assess the outlook for interest changes,
• underline the key relationships between yields and bond prices, and comment on the usefulness of duration’
• In particular, analyze the ‘Porsche’ bond, and demonstrate how its duration and convexity are calculated at end of June 1997 (given that the first coupon payment to be considered occurs in two months, at the beginning of September 1997).
Introduction
GBA was founded as an investment company by Jake Greydanus in the year 1984. It was then known as Greydanus & Associates Investments and its major financial activities were to provide management of fixed income to endowments and also pension funds[1]. Tony Boeckh, the owner of Bank Credit Analyst, joined the firm as an equal shareholder in 1986 when he acquired 50% ownership rights and the name of the company was changed to Gredanus, Boeckh & Associates. James Hymas joined the firm in 1995 after acquiring 5% ownership rights from Boeckh’s BCA Publications. Other associates who later joined were Yanan WU, Bing Li and Eric Deckert. GBA hired Centerfire Capital Management in 1997 as an exclusive marketing agent for the company. GBA currently manages over $1.7 billion worth of assets mostly in segregated pension funds, foundations, mutual funds, individual private investments as well as endowments. GBA [2]continues to expand and attract new clients due to its strong and successful track records. In the last seven years, GBA has gained over $400 million dollars in pension management.
GBA investments prefers to investment in government bonds that are largely considered safe. The company’s investment strategy and style is 80% quantitative value strategies while 20%
of the total investment portfolio is based on pure interest rate investment anticipation strategy which refers to the future determination of the direction or movements in interest rates. GBA has had its share of losses and successes in the market. For example between the years 1994 December and July 1995, GBA made a decision to time the future direction of interest rates. Apparently during this period the interest rates in the market were volatile and GBA had made big mistake as the interest rates were destined for a big drop due to the government’s highlights of long-term yields during the financial year.GBA had to engage the bar bell strategy to limit the risks that the interest timing would have exposed its investments to and the company had to cut down on potential losses that would have accrued to the firm had it not acted promptly and prudently.
Convexity measures the non-linear price and yield relationship to different bond duration and changes in interest rates. The bond price is more sensitive to changes in interest rates. Duration is basically the first derivative, the higher it is the more sensitive is the bond prices and also to changes in interest rates.[3]
Bond Prices
P1
Bond 1
PO
P Bond 2
Duration
Y1 YO Yield
Bond 1 in the example above has a convexity which is higher than for bond B2. If all other factors remain the same then the price of Bond 2 will be lower than the price of Bond 1 which should be higher due to fluctuation of interest rates. The more the convexity increases so does the increase in systemic risks of the portfolio increases. If the convexity decreases then the risk exposure to the market is also reduced and the portfolio is considered hedged. If the rate of coupon is high then the convexity of the bond will be low. In order for the bonds to be risky then the coupons must be lower than the market rates which is not easy. Duration is normally expressed in terms of years since the date of purchase. The duration of a bond influences the interest rates that the bond is subjected to. For example, if interest rates are increased by 1% that’s from 7 to 8% then the price of the bond that has duration of six years will certainly move downwards by 6% while a bond that has ten year duration will also move downwards by 10%.
Duration is largely important as it determines how bond prices move. Duration serves as a guide when determining or selecting bonds. The key relationship between bond prices and yields is that they are inversely related. A rise in yield performance leads to a drop in bond prices. When yield performance deteriorates then bond prices increases[4]
Porsche was one of the two governments bonds that were associated with the 911Porsche model car that had a coupon rate of 9.0 percent and the other one had 9.5 percent that were due in March 1 the year 2011 and June 1 the year 2010 respectively. The second bond that was due in 2010 was priced at 124.929 and a yield to maturity that was based on the bid price of 6.6014 percent with a convexity of 86.46 and a duration of 8.2282 years while the bond due in 2011 had a price of 120.885 and a yield based on bid price of 6.6489, a convexity of 93.21 and a duration of 8.4466 years.[5]
To calculate convexity the following formula is utilized;
C =D^2 –dD/dr
Bond duration changes as influenced by interest rates are reflected by the following formula;
D=1/1+r ∑n/i=1 P (i) t (i)/B
P (i) = Present value of coupon
t (i) = future payment date.
When the interest rates are increased, the PV of payments due in longer dated bonds reduces in accordance with the discounting factors earlier coupons. The prices of bonds also decrease as interest rates increases.
References
B G Leif & V Vladimir Interest Rate Modeling, Atlantic Financial Press, New York, 2010
C Paramasivan, & T Subramanian, Financial management, New Age International, New York, 2009, pg 47.
J Berk & P DeMarzo, Corporate Finance (Second ed.), Boston, MA: Prentice Hall, Boston, 2011, pp. 966–969
S Foerster, Greydaanus, Boeckh & Associates: The Yield Curve Kink Decision, Ivey Publishing, University of Western Ontario, Ontario, 2014 pp 2- 14.
[1] S Foerster, Greydaanus, Boeckh & Associates: The Yield Curve Kink Decision, Ivey Publishing, University of Western Ontario, Ontario, 2014 pp 2- 14.
[2] Ibid
[3] B G Leif & V Vladimir Interest Rate Modeling, Atlantic Financial Press, New York, 2010.
[4] J Berk & P DeMarzo, Corporate Finance (Second ed.), Boston, MA: Prentice Hall, Boston, 2011, pp. 966–969
[5] C Paramasivan, & T Subramanian, Financial management, New Age International, New York, 2009, pg 47.
