bullets, floaters, callables, & step-ups...2018/01/17 · bullets, floaters, callables, &...
TRANSCRIPT
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Bullets, Floaters, Callables, & Step-Ups
Rick PhillipsPresident and Chief Investment Officer
CDIAC-CMTAAdvanced Public Funds Investing
January 17, 2018
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1
Fundamentals
• You Can’t Predict Future Interest Rates• But Neither Can Anyone Else• Brokers Usually Make More on Callables
• Portfolio Strategies:• Cash Flow Matching vs. Indexing vs. Relative Value
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Forecasting—Market Timing
“The only function of economic (and interest rate) forecasting is to make astrology look respectable”.
John Kenneth Galbraith, Economist
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3
Market Timing…Not a Good Strategy
Source: Bloomberg
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4
Market Timing…Not a Good Strategy
Source: Bloomberg
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5
Market Timing…Not a Good Strategy
Source: Bloomberg
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6
Market Timing…Not a Good Strategy
Source: Bloomberg
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Market Timing…Not a Good Strategy
Source: Bloomberg
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Market Timing…Not a Good Strategy
Source: Bloomberg
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Portfolio Strategy: Cash Flow Matching
Month-End Portfolio Balance of a California City’s Pool
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Cash Flow Patterns
Month-End Portfolio Balance of a California County’s Pool
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Cash Flow Matching
Maturity Schedule a California County’s Pool
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Portfolio Strategy: Index Matching (1-5Yr)
Maturity Schedule a California City’s PoolLi
qu
idit
y in
a S
epar
ate
Port
folio
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Portfolio Strategy: Relative Value or Timing “Bets”
Source: Bloomberg, ICE
Would you sell corporates now?
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Portfolio Strategy: Relative Value
Source: Suntrust
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Bullets
Source: Bloomberg
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Bullets
Source: Bloomberg
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Bullets
Source: Bloomberg
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Bullets
Source: Bloomberg
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Bullets
Source: Bloomberg
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Bullets
Source: Bloomberg
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Floating Rate Notes
Source: Bloomberg
Floating Indexes: LIBOR, Fed Funds Effective, T-Bill, Prime Rate
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Floating Rate Notes
Source: Bloomberg
LIBOR
Prime Rate
T-Bill
Fed Fund Effective
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Floating Rate Notes
Source: Bloomberg
18 Month Security
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Floating Rate Notes
Source: Bloomberg
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Floating Rate Notes
Source: Bloomberg
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Floating Rate Notes
Source: Bloomberg
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Floating Rate Notes
Source: Bloomberg
Bullet’s YTM
.75%
1.63%
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Floating Rate Notes
Source: Bloomberg
Bullet’s YTM
24 Month Security
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Floating Rate Notes
Source: Bloomberg, FTN Main Street estimates
Bullet’s YTM
3 Rate Hikes in 2018, None in 2019 3 Rate Hikes in 2018, 3 in 2019
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Floating Rate Notes
Source: Bloomberg
Bullet’s YTM
“WAM Real Estate”
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Callables: Option Basics
Two Types of Options
Calls and Puts
When you purchase a callable bond, you are selling a call option to the issuer
What is the issuer’s right?
What is your obligation?
How are you getting paid when you sell that option?
What are some factors that determine option prices?
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Types of Callable Structures
European(One-Time)
American(Continuous)
Bermuda(On coupon or shorter)
(Discrete)
Canary(On coupon, then 1X)
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Are You Getting Paid For the Options You’re Selling?
Instrument Number of Calls Yield
Treasury 0 2.30%
Bullet 0 2.36%
One-Time Call 1 2.44%
Discrete Call (quarterly) 15 2.54%
Continuous Call* 1,450 2.60%
Source: Bloomberg, FTN Financial Capital Markets
5 Year Securities: Callables’ Lockouts 1 Year
*10 Day Call Notice
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Advanced Bond Math
Bullet Callable
Bond Convexity is a measure of the non-linear relationship of bond prices to changes in interest rates, the second derivative of the price of the bond with respect to interest rates (duration is the first derivative).
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Convexity and Effective Duration
Source: Bloomberg
5Yr T-Note
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Convexity and Effective Duration
Source: Bloomberg
5Yr
No
n-C
all 3
Mo
nth
5Yr
No
n-C
all 2
Yr 1
X
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Convexity and Effective Duration
Source: Bloomberg
5Yr
No
n-C
all 3
Mo
nth
Same Bond…Interest Rates Up 50 Basis Points (Bullet’ish)
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Effective Duration: Bullets 1-5Yrs vs. Callables 1-5Yrs
Effe
ctiv
e D
ura
tio
n
1-5 Yr Agency Bullet Index
1-5 Yr Agency Callable Index
Brexit
Source: Bloomberg
What’s the maximum % of callables you should have? What types of callables?
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Callable Breakeven Analysis
11 BPs x $10mil x 5Yrs = $55,000
If the callable gets called, this
is what the 4yr bullet rate
needs to be in one year to
equal the return of the 5yr
bullet.
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Callable Breakeven Analysis
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Three Types of Benchmarking
Keeping Score of Your Portfolio/Bonds
•Yield•Book Rate of Return•Total Rate of Return
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Calculation Methodology of Each Benchmark
Yield = Portfolio’s Weighted Average Purchase Yield
+ Accrued/Received Interest +/- Amortization/Accretion of Premiums/Discounts +/- Realized Gains/LossesAverage Daily Book Balance for the Period
Book Return=
Total Return=+ Accrued/Received Interest +/- Realized Gains/Losses+/- Unrealized Gains/Losses
Time Weighted Invested Market Value for the Period
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Book Return vs. Total Return
*Book Return = 12 Month Moving Average of Index’s Month-End Yield
Source: Bloomberg, FTN Main Street
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Performance Benchmarking
Source: Bloomberg, FTN Main Street
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Real World Example
Source: FTN Main Street
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Avg Prices: 1-5Yr Callables vs. 1-5Yr Bullets
Source: Bloomberg
1-5 Yr Bullets
1-5 Yr Callables
Avg
Pri
ce
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Total Return: Callables vs. Bullets
Source: Bloomberg
1-5 Yr Callables
1-5 Yr Bullets
Tota
l Ret
urn
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Effective Duration: Callables vs. Bullets
Source: Bloomberg
1-5 Yr Bullets
1-5 Yr Callables
Effe
ctiv
e D
ura
tio
n
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Effective Duration: Callables vs. Bullets
Source: Bloomberg
1-5 Yr Callables
1-3 Yr Bullets Effe
ctiv
e D
ura
tio
n
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Total Return: Callables vs. Bullets
Source: Bloomberg
1-5 Yr Callables
1-3 Yr Bullets
Tota
l Ret
urn
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Total Return: Callables vs. Bullets
Source: Bloomberg
1-5 Yr Callables
1-3 Yr Bullets
Tota
l Ret
urn
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Callable Cost of Carry Analysis
Source: Bloomberg, FTN Main Street
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5Yr Step-Up Callable vs. 5Yr Fixed Rate Callable
Source: Bloomberg
Fixed Rate
Breakeven Holding Period
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Step-Up: OAS, Effective Duration, Convexity
5Yr Step- Up, 1Yr Lockout, Callable Annually
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Callable: OAS, Effective Duration, Convexity
Source: Bloomberg
5Yr Fixed Rate Callable, 1 Yr Lockout, Callable Continuously
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Volatility Matters
Source: Bloomberg
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Volatility Matters
Source: Bloomberg
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Final Questions or Comments
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Disclosure
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