【正文】 nce we are asked to calculate horizon return over a period of only one coupon period, there is no reinvestment ine.Horizon return = CIC: PTR: c. Notice that CIC is noncallable but PTR is callable. Therefore, CIC has positive convexity, while PTR has negative convexity. Thus, the convexity correction to the duration approximation will be positive for CIC and negative for PTR.8. The economic climate is one of impending interest rate increases. Hence, we will seek to shorten portfolio duration.a. Choose the short maturity (2014) bond.b. The Arizona bond likely has lower duration. The Arizona coupons are slightly lower, but the Arizona yield is higher.c. Choose the 9 3/8 % coupon bond. The maturities are approximately equal, but the 9 3/8 % coupon is much higher, resulting in a lower duration.d. The duration of the Shell bond is lower if the effect of the earlier start of sinking fund redemption dominates its slightly lower coupon rate.e. The floating rate note has a duration that approximates the adjustment period, which is only six months, thus choose the floating rate note.9. a. A manager who believes that the level of interest rates will change should engage in a rate anticipation swap, lengthening duration if rates are expected to fall, and shortening duration if rates are expected to rise.b. A change in yield spreads across sectors would call for an intermarket spread swap, in which the manager buys bonds in the sector for which yields are expected to fall relative to other bonds and sells bonds in the sector for which yields are expected to rise relative to other bonds.c. A belief that the yield spread on a particular instrument will change calls for a substitution swap in which that security is sold if its yield is expected to rise relative to the yield of other similar bonds, or is bought if its yield is expected to fall relative to the yield of other similar bonds.10. a. The advantages of a bond indexing strategy are Historically, the majority of active managers underperform benchmark indexes in most periods。 indexing reduces the possibility of underperformance at a given level of risk. Indexed portfolios do not depend on advisor expectations and so have less risk of underperforming the market. Management advisory fees for indexed portfolios are dramatically less than fees for actively managed portfolios. Fees charged by active managers generally range from 15 to 50 basis points, while fees for indexed portfolios range from 1 to 20 basis points (with the highest of those representing enhanced indexing). Other nonadvisory fees (., custodial fees) are also less for indexed portfolios. Plan sponsors have greater control over indexed portfolios because individual managers do not have as much freedom to vary from the parameters of the benchmark index. Some plan sponsors even decide to manage index portfolios with inhouse investment staff. Indexing is essentially “buying the market.” If markets are efficient, an indexing strategy should reduce unsystematic diversifiable risk and should generate maximum return for a given level of risk.The disadvantages of a bond indexing strategy are Indexed portfolio returns may match the bond index, but do not necessarily reflect optimal performance. In some time periods, many active managers may outperform an indexing strategy at the same level of risk. The chosen bond index and portfolio returns may not meet the client objectives or the liability stream. Bond indexing may restrict the fund from participating in sectors or other opportunities that could increase returns.b. The stratified sampling, or cellular, method divides the index into cells, with each cell representing a different characteristic of the index. Common cells used in the cellular method bine (but are not limited to) duration, coupon, maturity, market sectors, credit rating, and call and sinking fund features. The index manager then selects one or more bond issues to represent the entire cell. The total market weight of issues held for each cell is based on the target index’s position of that characteristic.c. Tracking error is defined as the discrepancy between the performance of an indexed portfolio and the benchmark index. When the amount invested is relatively small and the number of cells to be replicated is large, a significant source of tracking error with the cellular method occurs because of the need to buy odd lots of issues in order to accurately represent the required cells. Odd lots generally must be purchased at higher prices than round lots. On the other hand, reducing the number of cells to limit the required number of odd lots would potentially increase tracking error because of the mismatch with the target.11. a. For an optionfree bond, the effective duration and modified duration are approximately the same. Using the data provided, the duration is calculated as follows:b. The total percentage price change for the bond is estimated as follows:Percentage price change using duration = – – 100 = %Convexity adjustment = %Total estimated percentage price change = % + % = %c. The assistant’s argument is incorrect. Because modified convexity does not recognize the fact that cash flows for bonds with an embedded option can change as yields change, modified convexity remains positive as yields move below the callable bond’s stated coupon rate, just as it would for an optionfree bond. Effective convexity, however, takes into account the fact that cash flows for a security with an embedded option can change as interest rates change. When yields move significantly below the stated coupon rate, the likelihood that the bond will be called by the issuer increases and the effective convexity turns negative.12. ?P/P = ?D* ?yFor Strategy I:5year maturity: ?P/P = ? (?%) = %25year maturity: ?P/P = ? % = ?%Strategy I: ?P/P = ( %) + [ (?%)]