Greydanus, Boeckh & Associates: The Yield Curve Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Greydanus, Boeckh & Associates: The Yield Curve Case Study Solution

Analysis

The valuation of the bond depends on many factors such as coupon rate, term to maturity and market conditions. Since the value of the bond depends on many factors, therefore it will be difficult to estimate the value bond accurately. The price of the bonds provides better indication of the performance of the bond. The higher interest rate does not result in higher yield for the bond.

The longer maturity of bonds exposes to higher interest rate risk as it is difficult to predict the interest rates for longer terms. Apart from maturity, the redemption of the bond is might be vital for valuation of bond in some cases. In the case when the issuer of bond provides the option to the investor, which includes an offer for an investor to redeem the bond at specific price, then in that case the price of the bond is higher as it is attached with benefit.

Duration of the bond provides the determination of interest rate risk on the bonds. Bonds are subject to interest rate risk as the enhancement of interest rates will lead to reduction in prices of bonds. Moreover, duration provides the weighted average present values of the bond payments. Therefore, the higher duration for the bond would lead to higher average maturity, which in turn, would increase the sensitivity toward the interest rate changes.

Furthermore, duration provides the percentage change in the price of bond with a change in yield to maturity of the bond. Duration is only useful for small changes in interest rates because of convexity. The relationship between interest rate and price is nonlinear in fact it is convex. Higher convexity indicates the higher gap between the modified duration and price yield curve. For the evaluation of the performance of GBA multiple methods were used. First of all, the Sharpe ratio was calculated which indicates that the performance of the funds is quite better than the benchmark. Although assumption was taken for the calculation purposes however, these are based on industry practise so that the results generated are close to reality.

Apart from Sharpe ratio, Treynor ratio is calculated, which indicates that in 1991 the fund performed very well in generating higher return as compared to the benchmark. Lastly, Jensen Alpha was calculated in order to determine the historic performance of GBA fund. The result from Jensen Alpha is different from the methods used previously as it generated.

The market demands for higher rate of return from GBA fund as the beta of the fund is 1.02 however, the fund generates lower than the market expectation. GBA intends to increase its return higher by 50 basis points against the benchmark. The goal of higher 50 basis point seems to be realistic as the historic performance indicates that in year 1995 and 1993, the fund performs well and generate higher return for their investors. It can be possible for the fund to continue higher return generation for its investors. In order to generate additional return, the fund has to enhance its risk profile.

GBA intends to invest heavily on these two bonds therefore, the risk associated with these bonds have to be examined before investment. Furthermore, the performance of the bonds has to be regularly evaluated and assessed. The 9.5% coupon rate bond of June 2010 indicates the premium price bond as it provides higher rate of return as compared to market demand. It might provide capital gain for the funds in case of reduction in interest rates as the price of bond will increase. The fund invests consequently in 9% coupon rate bond, which would mature in 2011, and that bond would indicate the higher convexity, which might be a risk for funds return in longer term in case when the interest rate will move against the fund.

Greydanus, Boeckh & Associates The Yield Curve Harvard Case Solution & Analysi

Decision:

After analysing the case, it has been determined that the fund’s performance is not reasonable and that there is room for improvement. In order to enhance its returns generation, the fund has to increase its risk profile up to the reasonable level. The longer dated bonds are more subject to interest rate risk; therefore investment in those bonds might increase the funds risk. For increasing risk long dated bond will be essential for investment however, only those bonds should be opted, which suit the funds risk appetite higher than risk appetites, which would lead to loss of value.................

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