Course Code and Title : FINE-4 –Mutual Fund

Lesson Number : 7
Topic : Management of Bond Fund Portfolio
Professor : Prof. Romualdo S. Del Agua

INTRODUCTION:

A bond portfolio can be managed in several ways; however, the primary methods are active,
passive, or a hybrid of the two. Active bond portfolio management, as the name suggests,
means the portfolio manager takes an active role in the running, organizing, and management
of the portfolio.

LEARNING OBJECTIVES:

1. To maximize returns in the long run by investing in marketable securities such as equity,
debt,cash, and commodity, etc.
2. To help the client to reduce the risk through proper diversification and provide
customized solutions for achieving the client's goals.

LESSON PRESENTATION:

management of the portfolio of bonds and the steps are taken in achieving this objective. ...
supply of funds available for investment with the need for long-term capital assets issued by
sectors of the economy 

Seasoned investors know the importance of diversification. Mixing up your portfolio with

different asset classes is probably the best way to generate consistent returns—stocks,
currencies, derivatives, commodities, and bonds.Basics of Bond Investing Bonds are a form
 of debt issued by a company or government that wants to raise some cash. In essence, when
an entity issues a bond, it asks the buyer or investor for a loan.
Interest rate risk: Interest rates have an inverse relationship with bond prices. So when you buy a
bond, you commit to receiving a fixed rate of return (ROR) for a set period. Should the market rate
rise from the date of the bond's purchase, its price will fall accordingly. The bond will then trade at
a discount to reflect the lower return that an investor will make on the bond.

The inverse relationship between market interest rates and bond prices holds under falling interest-
rate environments as well. The originally issued bond would sell at a premium above par value
because the coupon payments associated with this bond would be greater than the coupon payments
offered on newly issued bonds. As you can infer, the relationship between the price of a bond and
market interest rates is simply explained by the supply and demand for a bond in a changing interest-
rate environment.

Market interest rates are a function of several factors including the supply and demand for money in
the economy, the inflation rate, the stage that the business cycle is in, and the
government's monetary and fiscal policies.

Supply and Demand

Interest rate risk is also fairly easy to understand in terms of supply and demand. If you purchased a
5% coupon for a 10-year corporate bond that sells at par value, the investor would expect to receive
$50 per year, plus the repayment of the $1,000 principal investment when the bond reaches maturity.

Reinvestment Risk

Another risk associated with the bond market is called reinvestment risk. In essence, a bond poses a
reinvestment risk to investors if the proceeds from the bond or future cash flows will need to be
reinvested in a security with a lower yield than the bond originally provided. Reinvestment risk can
also come with callable bonds—investments that can be called by the issuer before the maturity rate.

For example, imagine an investor buys a $1,000 bond with an annual coupon of 12%. Each year, the
investor receives $120 (12% x $1,000), which can be reinvested back into another bond. But imagine
that, over time, the market rate falls to 1%. Suddenly, that $120 received from the bond can only be
reinvested at 1%, instead of the 12% rate of the original bond.

For example, most federal governments have very high credit ratings (AAA). They have the means to
pay their debts by raising taxes or printing, making default unlikely. However, small emerging
companies have some of the worst credit—BB and lower—and are more likely to default on their
bond payments.2 In these cases, bondholders will likely lose all or most of their investments.

Inflation Risk

This risk refers to situations when the rate of price increases in the economy deteriorates the returns
associated with the bond. This has the greatest effect on fixed bonds, which have a set interest rate
from inception.

For example, if an investor purchases a 5% fixed bond, and inflation rises to 10% per year, the
bondholder will lose money on the investment because the purchasing power of the proceeds has
been greatly diminished. The interest rates of floating-rate bonds or floaters are adjusted periodically
to match inflation rates, limiting investors' exposure to inflation risk.

An analysis of the bond market and the strategies that successful active managers can employ
suggests five important potential advantages that can contribute to outperformance. 

1. Capturing Opportunities

The unique nature of the U.S. bond market creates opportunities that active management can
capture. 

2. Conscious Risk Control

Passively managed funds are designed to track various benchmark fixed-income indexes
(representing sectors such as high yield, floating rate, and others).

3. Thoughtful Credit Selection

Beyond controlling overexposure to less-desirable sectors, active credit analysis can inform individual
security selection through identifying credits with weak management or deteriorating financial
conditions.

4. Opportunistic Sector Rotation

The analytical approach used by active managers when evaluating individual credits can be
expanded and applied to sectors.

5. Alignment with Client Interest

Actively managed portfolios also may offer a better fit with a client’s objectives and risk tolerances
than a passive approach can accomplish.

The Active Advantage

Active decision making allows for a wide range of styles and outcomes. Of course, not all active
management is equally successful, nor is every investment style appropriate for every investor. 

Exchange-Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets
like an index fund, but trades like a stock on an exchange. ETFs experience price changes
throughout the day as they are bought and sold.

GENERALIZATION:

At this point, the students should have learned about the strategies used to manage bond
portfolios Cash flows from the bonds can be used to fund external income needs or can be
reinvested in the Indexing is considered to be quasi-passive by design.

ACTIVITY/EVALUATION
Direction: Write your answer on a yellow sheet paper
(10 pts) Fill up the missing words.
.
The ________________1. of floating-rate bonds or __________2. are adjusted periodically to match
______________3, limiting investors' exposure to inflation risk.

The_________________4. Interest rates have an inverse relationship with ___________5. So when

you buy a bond, you commit to receiving a fixed rate of_____________6. for a set period. Should the
market rate ________7. from the date of the bond's purchase, its price will fall accordingly. The bond
will then trade at a __________8. to reflect the ___________9. that an investor will make on the
_________10.

REINFORCEMENT:
Direction: Write your answer on a yellow sheet paper.
Define the meaning of the following:
1. Large Cap,
 2.Mid Cap

3. Small-Cap.

REFERENCES:(Chapter-7)

https://www.studocu.com/en-nz/document/auckland-university-of- technology/investment-
and-portfolio-analysis/lecture-notes/lecture-10-notes-managing- bond-portfolio/2068008/
view (management of bond fund portfolio)advance reading assignment.
https://slideplayer.com/slide/5024502/ Management of bond fund portfolio) ppt