The manager of the Bontemps International (BI) defined-benefit pension plan's fixed-income portfolio has shown exceptional security selection skills and has produced returns consistently above those on BI's fixed-income benchmark portfolio. The board wants to allocate more money to this manager to enhance further the fund's alpha. This action would increase the proportion allocated to fixed income and decrease the proportion in equities. However, the board wants to keep the present fixed-income/equity proportions unchanged.
a. Identify two distinct strategies using derivative financial instruments that the board could use to increase the fund's allocation to the fixed-income manager without changing the present fixed-income/equity proportions. Briefly explain how each of these two strategies would work. (Note: Make sure that equity swaps are one of the two strategies that you choose.)
b. Briefly discuss one advantage and one disadvantage of each of the strategies you identified in Part a. Present your discussion in terms of the effect(s) of these advantages and disadvantages on the portfolio's (1) risk characteristics and (2) return characteristics.

  • CreatedDecember 17, 2014
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