Strategies for Managing your Agency’s Investments

Tim Johnson, CFAManaging DirectorSenior Fixed Income Strategist

April 17, 2013

Portfolio Strategy & Analytics – Extension Risk

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Assess portfolios to identify risks that could be very problematic. It is important to improve portfolio structure today to avoid potential pitfalls ahead.

Both portfolios have a similar effective duration when interest rates are unchanged (notice today is “0” in the center of the two charts on the left).

+300 bps shock- 5.16% total return

Extension Risk What is it? What causes

it?

+300 bps shock

- 22.3% total return

0 1 2 3 4 5 6 7 8 9 100

5

10

15

20

25

30

35

Final Maturity Effective Maturity

Time to Maturity Graph

Portfolio Strategy & Analytics – Coupon Type

Coupon Type Matters………

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Par Value Mkt Value Cash Ann Income Quality CouponMaturity

(Yrs) Avg LifeCurr

Yield YTW Mod Dur Eff Dur Conv

Before 1,000,000 1,000,229 0 6,250 Aaa 0.625 4.992 5.000 0.625 0.622 4.904 4.935 0.132

After 711,000 1,000,166 0 63,101 Aaa 8.875 4.947 4.917 6.331 0.613 4.231 4.250 0.107Difference -289,000 -63 0 56,851 8.250 -0.044 -0.083 5.706 -0.009 -0.674 -0.684 -0.025

Sell the current .625% 5yr Treasury and BUY 5yr 8.875% coupon.

Improve total return performance by up to +187 basis points in +50 to +300 basis point shock environments.

Increase Annual Income by $56k

Decrease Effective Duration by .6 years.

Yield and market value neutralYield Chg

(bps) Before After Diff

-300 16.699 14.336 -2.363

-250 13.828 11.892 -1.936

-200 11.043 9.517 -1.526

-150 8.329 7.201 -1.128

-100 5.687 4.943 -0.744

-50 3.120 2.746 -0.374

0 0.622 0.605 -0.017

50 -1.811 -1.484 0.327

100 -4.179 -3.519 0.660

150 -6.481 -5.502 0.979

200 -8.722 -7.435 1.288

250 -10.906 -9.321 1.585300 -13.027 -11.156 1.871

Portfolio Strategy & Analytics – Bond Coupon

Source: Bondedge

Average Coupon Matters………

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Portfolio Strategy & Analytics – Fixed vs Floating

Fixed Rate Bullet vs Floating Rate Bullet

Source: Bondedge

Ann Income Quality Coupon

Maturity (Yrs)

Avg Life

Curr Yield YTW

Mod Dur Eff Dur Conv

Fixed Rate - Bullet 31,000 A1 3.100 9.764 9.750 3.100 3.099 8.309 8.565 0.419

Floater - Bullet 12,811 A1 1.281 9.917 9.917 1.278 1.254 9.415 0.102 -0.008Difference -18,189 -1.819 0.153 0.167 -1.822 -1.845 1.106 -8.463 -0.427

The Floater bond will yield 185 basis points less than the Fixed Rate bond.The Floater bond will currently have a lower Annual Income and Coupon.

Yield Chg (bps)Fixed Rate

- BulletFloater -

Bullet Diff

-300 32.886 6.915 -25.972

-250 27.266 4.644 -22.622

-200 21.950 2.830 -19.120

-150 16.881 1.804 -15.077 If interest rates are flat or fall, the Fixed Rate bond outperforms.-100 12.048 1.385 -10.663

-50 7.452 1.341 -6.110

0 3.078 1.298 -1.780

50 -1.087 1.263 2.350

100 -5.053 1.195 6.248

150 -8.828 1.134 9.962 If interest rates rise, the Floater bond outperforms.200 -12.428 1.077 13.505

250 -15.862 1.014 16.876300 -19.122 0.946 20.068

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Portfolio Strategy & Analytics – Fixed vs Cushion Callable

Fixed Rate Bullet vs Fixed Cushion Callable

Source: Bondedge

Ann Income Quality Coupon

Maturity (Yrs)

Avg Life

Curr Yield YTW

Mod Dur Eff Dur Conv

Fixed Rate - Bullet 31,000 A1 3.100 9.750 9.750 3.084 3.039 8.302 8.552 0.418

Fixed - Callable 50,000 A1 5.000 9.933 0.417 4.966 3.392 7.799 2.924 -2.353Difference 19,000 1.900 0.183 -9.333 1.882 0.353 -0.503 -5.629 -2.771

The Callable bond will yield 35 basis points more than the Fixed Rate bond.The Callable bond will have a higher Annual Income and Coupon.

Yield Chg (bps) Before After Diff

-300 32.774 4.767 -28.006

-250 27.164 4.576 -22.587

-200 21.857 4.344 -17.513

-150 16.797 4.055 -12.742 If interest rates fall, the Fixed Rate bond outperforms.-100 11.972 3.924 -8.048

-50 7.384 3.646 -3.737

0 3.017 3.369 0.352

50 -1.142 1.257 2.399

100 -5.102 -1.892 3.210

150 -8.872 -5.397 3.475 If interest rates are flat or rise, the Callable bond outperforms.200 -12.466 -8.914 3.553

250 -15.897 -12.235 3.662300 -19.152 -15.355 3.797

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Portfolio Strategy & Analytics – Cushion Callable vs Floating

Fixed Cushion Callable vs Floating Rate Bullet

Source: Bondedge

Ann Income Quality Coupon

Maturity (Yrs)

Avg Life

Curr Yield YTW

Mod Dur Eff Dur Conv

Fixed - Callable 50,000 A1 5.000 9.933 0.417 4.966 3.392 7.799 2.924 -2.353

Floater - Bullet 12,811 A1 1.281 9.917 9.917 1.281 1.281 9.400 0.073 -0.009Difference -37,189 -3.719 -0.017 9.500 -3.685 -2.111 1.602 -2.851 2.343

The Floater bond will yield 211 basis points less than the Fixed Callable bond.The Floater bond will have a lower Annual Income and Coupon.

Yield Chg (bps)Fixed -

CallableFloater -

Bullet Diff

-300 4.767 6.960 2.192

-250 4.576 4.685 0.109

-200 4.344 2.856 -1.488

-150 4.055 1.797 -2.258 If interest rates are flat or fall, the Callable bond outperforms.-100 3.924 1.355 -2.569

-50 3.646 1.327 -2.319

0 3.369 1.299 -2.070

50 1.257 1.280 0.023

100 -1.892 1.224 3.116

150 -5.397 1.176 6.573 If interest rates rise, the Floater bond outperforms.200 -8.914 1.134 10.048

250 -12.235 1.085 13.319300 -15.355 1.030 16.384

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Portfolio Strategy & AnalyticsFed Funds and 30 year Treasury – yields on top and spreads below.

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