CASE - Rensselaer Advisers

QUESTIONS

1. Prepare a memo for Mr. van Wie explaining how RA would invest to minimize both risk and exposure to changing interest rates. Give an example of a portfolio that would accomplish this objective. Explain how the portfolio would be managed as time passes and interest rates change. Also explain why SPX's proposal is not advisable for a conservative company like Madison.

RA manages several fixed-income portfolios. For simplicity, you decide to propose a mix of the following three portfolios:

• A portfolio of long-term Treasury bonds with an average duration of 14 years.
• A portfolio of Treasury notes with an average duration of 7 years.
• A portfolio of short-term Treasury bills and notes with an average duration of 1 year. The term structure is flat, and the yield on all three portfolios is 5%.

2. Sorry, you lost. SPX won and implemented its proposed strategy. Now the recession of 2015 has knocked down U.S. stock prices by 20%. The value of the Madison portfolio, after paying benefits for 2015, has fallen from $90 million to $78 million. At the same time interest rates have dropped from 5% to 4% as the Federal Reserve relaxes monetary policy to combat the recession.

Mr. van Wie calls again, chastened by the SPX experience, and he invites a new proposal to invest the pension assets in a way that minimizes exposure to the stock market and changing interest rates. Update your memo with a new example of how to accomplish Mr. van Wie's objectives. You can use the same portfolios and portfolio durations as in Question 1. You will have to recalculate the PV and duration of the pension benefits from 2016 onward. Assume a flat term structure with all interest rates at 4%. (Hint: Madison's pension obligations are now underfunded. Nevertheless you can hedge interest rate risk if you increase the duration of the pension assets.)

Attachment:- Case.rar