...may have while determining the course of action for the portfolio. Section 2: Harvard would like to use funds from the endowment to distribute money to the schools within the university, while at the same time preserving the real value of the endowment and allowing for some real growth in the income distributions. Harvard is currently looking for a real return of 6% to 7% to ensure that distribution of 3% to 4% can be maintained. The university’s investment horizon is nearly limitless, assuming that Harvard will be continuing as a university. For an institution that will not end its endowment in the foreseeable future, inflation is always a concern. This concern can be addressed by predicting inflation based on the Higher Education Price Index (HEPI) over the Consumer Price Index (CPI). The endowment does not have to do all the work to battle inflation. As only a quarter of the university’s income the endowment income will also be balanced by tuition, donations, and research grants. Historically donations have been about 1% of...
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...Services at Bentley College for the data and the second author thanks Bentley College for a summer research grant. The usual disclaimer applies. Are TIPS the “Real” Deal?: A Conditional Assessment of their Role in a Nominal Portfolio Abstract This paper documents predictable time-variation in the real return beta of U.S. Treasury inflation protected securities (TIPS) and in the Sharpe ratios of both indexed and conventional bonds. The conditional mean and volatility of both bonds and their conditional correlation are first estimated from predetermined variables. These estimates are then used to compute conditional real return betas and Sharpe ratios. The time-variation in real return betas and the correlation between TIPS and nominal bonds coincides with major developments in the fixed income market. One implication of this predictability is that portfolio managers can assess more efficiently the risk of investing in TIPS versus conventional bonds. Conditional Sharpe ratios indicate that over the sample period, TIPS had superior volatility-adjusted returns relative to nominal bonds. This finding is striking in view of the absence of a major inflation scare during the sample period from February 1997 through August 2001, but is loosely consistent with the possibility that TIPS elevated rather than reduced Treasury borrowing costs. On the other hand, mean-variance spanning tests...
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...Bond Valuation: * How do we use NPV to value bonds? One simply computes the present value of the cash flows at the appropriate rate of return. This corresponds approximately to the full price of the bond (as opposed to the listed price). * E.g.: a one period, $1000 bond, 10% coupon is valued at: $1037 (1100/1.06) if the market rate of return is 6%. The bond sells at a premium. * $1000 if the market rate of return is 10%. The bond sells at par. * $982 if the market rate of return is 12%. The bond sells at a discount. Tentative Conclusions * The higher the appropriate interest rate, the lower the price of the bond. * If the yield matches the coupon , then the bond sells at par. * If the yield is higher than the coupon, the bond sells at a discount. * If the yield is lower than the coupon, the bond sells at a premium Example: * Consider now an infinite bond, paying a 10% coupon, i.e. $100 forever. * Then if the market return is 10% the bond sells at 100/0.1 =1000. * If the market return is 6% the bond sells at 100/0.06 = 1667 * If the market return is 12% the bond sells at 100/0.12 = 833 * A tentative conclusion: it seems that longer maturity bonds are affected more by interest rate swings. * We will modify this conclusion later. Valuing a Bond * If today is October 1, 2010, what is the value of the following bond? An IBM Bond pays $115 every September 30 for 5 years. In September 2015 it pays...
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...TIPS Federico Martinoli 1) TIPS are an inflation-indexed form of debt: they are 10 year treasury notes with semiannual coupon payments. Both the principal and the coupons are adjusted every semester by the percentage raise of the Consumer Price Index (CPI). Therefore if a CPI has a nominal value of 100 and pays 2% interest and the CPI raises by 5% the principal will become USD 105 and the coupon will be USD 2.1 (so the interest rate against the principal remains 2% but it becomes 2.1% of the original face value of the bond). To the contrary in case of deflation the TIPS would never fall below the face value. Different types of inflation indexed securities are sold by other governments like the UK, Brazil, Chile, Israel, Australia, etc.). This is not the only possible way to structure an inflation-indexed bond. A bond could be structured to only adjust its coupon and not the principal, or it could also be structured to adjust for deflation. TIPS are probably the best structure for small investors that are investing their savings for their retirement or for their kid’s college as they adjust both principal and coupon only upwards. 2) The price of TIPS is affected by the current yield of other forms of government securities and in general by the economic condition of the issuing country. In fact if the issuing country goes into a recession and the yields of the various treasuries rise also the TIPS yield will rise causing the TIPS bond price to fall and vice-versa in a case of...
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...9-201-129 REV: OCTOBER 23, 2001 Harvard Management Company (2001) In February 2001, Jack Meyer gazed out of his fifteenth floor office window at a cold Boston Harbor and reflected on the set of issues facing Harvard Management Company (HMC). The HMC Board would soon be reviewing the Policy Portfolio – the long-term asset mix that was designed to balance Harvard’s aversion to risk against its needs for long-term endowment returns. The Policy Portfolio was the cornerstone of endowment management at Harvard, the “neutral” portfolio mix that anchored the central tendency of actual asset allocations over time, as well as the benchmark against which actual performance was measured and incentive compensation was calculated. The Board was also interested in a variety of related issues, including the complexity of the investment strategies employed, the effectiveness of their risk controls, and the design and administration of their compensation systems. The Role of the Endowment Harvard University had been founded in 1636, and from the beginning its endowment played an important role in the financial structure of the institution. As of June 2000, the endowment managed by HMC totaled approximately $18.2 billion. Each of the various schools within the University owned “units” in the endowment, much like an individual would own shares in a mutual fund. Spending from the endowment was distributed pro-rata to all schools on the basis of the units each school owned. The annual spending from...
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...HARVARD MANAGEMENT COMPANY Answer 1: The general objective of HMC was to try to preserve the real value of the endowment and its income distribution in perpetuity. In the last years the endowment spending was on average 4.6%, annual gifts averaged about 1.5%, and Harvard expenses continued to grow at a rate of 3% above CPI. If in the long run the endowment was able to earn a 6% to 6.5% average return over the CPI inflation rate the university could spend 4.5% to 5% of the endowment. The 6.25% is the average of the real minimum expected returns (6% and 6.5%) that HMC could earn to meet the annual spending. Answer 2: The Policy Portfolio is a long term asset mix that was designed to balance HMC’s aversion to risk against its needs for long-term endowment returns. It is the portfolio that Harvard should maintain under neutral conditions. It had a smaller weighting in US and foreign stocks and a larger weighting in cash and private investments than other managed funds of the time. It is based on long term return and risk assumptions to meet Harvard’s return goals, risk tolerance, and long term scenario. The Policy Portfolio specified neutral weighting for each asset class, but HMC could deviate from these weights by moving the asset class weight away from policy in anticipation of short-term moves. HMC was given a minimum and maximum range for each asset class within which they could move without prior consultation with the HMC Board. From our point of view, the Policy Portfolio...
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...the key measure of inflation. Earlier, RBI had given more weightage to Wholesale Price Index (WPI) than CPI as the key measure of inflation for all policy purposes. “Some recommendations of Urjit R. Patel Committee report have been implemented, including adoption of the new CPI (combined) as the key measure of inflation,” said Dr. Rajan, while addressing a press conference here to announce the first bi-monthly monetary policy for 2014-15. This also includes explicit recognition of the glide path for disinflation, transition to a bi-monthly monetary policy cycle, progressive reduction in access to overnight liquidity at the fixed repo rate, and a corresponding increase in access to liquidity through term repos, and introduction of longer-tenor term repos as well as, going forward, term reverse repos. Following on the recommendations of the high-level advisory committee chaired by Bimal Jalan, and after consulting the Election Commission, the RBI will announce in-principle approval for new bank licences. “Immediately after, and using the learning from the licensing exercise as well as building on its previously-released discussion paper on banking structure, the Reserve Bank will work to giving licences more regularly, that is virtually “on-tap”. It will also set out categories of differentiated bank licences that will allow a wider pool of entrants into banking,” Dr. Rajan added. Inflation Indexed Bonds To expand investor demand for inflation-indexed bonds, Dr. Rajan said,...
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...years. Not all assets that have been labelled fixed income are “true to label”, and furthermore, not even all bonds are made equal. Advisers need to be aware that some are inherently much more risky than others, and others are just not fit for purpose if the objective is to create a safe, predictable source of income that also diversifies a portfolio’s equity risk. FIXED INTEREST/BONDS – A DEFINITION Broadly, a bond can be defined as any debt instrument issued by a government/quasi-government entity or company/special purpose vehicle. In effect a bond is a commoditised, tradable loan where an investor provides capital in exchange for a legally enforceable promise by the issuer to pay the investor regular interest over a fixed period of time and principal at maturity. Naturally, the ability to enforce payment will be a function of the solvency of the borrower. Therefore, assessing credit quality is vital in fixed interest investing. High quality issuers generally fund at lower yields whereas higher yields are paid by issuers of lower credit quality due to a higher risk of default. The tradability of fixed interest securities means that their prices fluctuate in concert with movements in interest rates, whilst providing liquidity for investors needing to access their funds or wanting to change investment strategy. An Example An investor who holds a government bond with a face value of $10,000, paying a coupon of 6% and a maturity of five years,...
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...1. [Treasury Bonds, Notes & Bills: 24 Points] a. (2 points) From your Barron’s, find a Treasury bill maturing in three months from the date of your Barron’s in 2015. For example, if the date of your Barron’s is February 15 (October 1, 2015), then choose a Treasury bill maturing around May 15 (January 1, 2016). * Find a Treasury bond or note maturing one year from the date of your Barron’s in 2015. For example, if the date of your Barron’s is February 15, 2015, then choose a Treasury bond or note maturing in February 2016 * b. (10 points) Referring to the Treasury bill chosen on Question (a) above, compute a “number of days to maturity” on the Treasury bill from the date of your Barron’s to its maturity date. For example, if the date of your Barron’s is February 15, and the maturity date of the Treasury bill is May 15, then there will be 89 days to maturity (13 + 31 + 30 + 15). [Show your computation work] * Maturity date – Sept 24, 2015; Barron Date – June 22, 2015 * 8 + 31 + 31 + 24 = 94 number of days to maturity Compute actual asked dollar price of the Treasury bill, assuming $1,000 face value. [Show your computation work] * 99.857 x 10 = 998.57 Using the annual coupon payment and the actual asked dollar price that you computed above, compute the yield to maturity of the Treasury bond, assuming the next coupon payment will be given on the maturity day. [Show your computation work] I = F –P / F x 360 / days to maturity =...
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...Financial Markets Q1. HMC’s aims to provide relatively predictable cash flows from the endowment to the different schools within the university. As stated in the case, “the general objective was to preserve the real value (adjusted for Harvard’s expense growth) of the endowment and its income distribution in perpetuity”. In recent years, the payout ratio (Endowment spending as a % of total Endowment value) has had a target range of 4.5% to 5.0%. In the case’s example, the average growth rate of Harvard’s expenses is 3% above CPI inflation rate and annual gifts to the endowment average about 1.5%. Hence, with a payout ratio target of 4.75%, we would get an Expected Return of 6.25%: 4.75% + 3% - 1.5% = 6.25% Q2. The Policy Portfolio is the “neutral” guide of long-term asset allocation set by the HMC board and it serves as a benchmark of actual performance and as a metric against which compensation of portfolio managers is measured. The aim of the Policy Portfolio is to provide targets for different asset categories as a percentage of the total portfolio, in order to achieve a long-term expected return with the least risk possible. The policy portfolio is reviewed every year and it is modified as a result of changes in market conditions, needs for long-term expected returns, and risk aversion. Jack Meyer’s vision was to keep the actual asset mix “fairly” close to the Policy Portfolio. Fairly close means that the Policy Portfolio included a minimum and a maximum percentage...
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... Yan Li Treasury Inflation Protected Securities – TIPS Definition----A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed. Interest on TIPS is paid semiannually. TIPS can be purchased directly from the government through the TreasuryDirect system in $100 increments with a minimum investment of $100 and are available with 5-, 10-, and 20-year maturities. Investopedia explains 'Treasury Inflation Protected Securities - TIPS' Because a TIPS bond's semiannual inflation adjustments are considered taxable income by the IRS even though investors don’t see that money until they sell the bond or it reaches maturity, some investors prefer to get TIPS through a TIPS mutual fund or only hold them in tax-deferred retirement accounts to avoid tax complications Purchasing TIPS directly, however, allows investors to avoid the management fees associated with mutual funds. TIPS are also valuable because they are exempt from state and local income taxes. Summary of Marketable Treasury Inflation-Protected Securities The Treasury Department published final rules on January 6, 1997, which sets out the terms and conditions for marketable inflation-protected securities. The final rules...
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...Financial Markets Q1. HMC’s aims to provide relatively predictable cash flows from the endowment to the different schools within the university. As stated in the case, “the general objective was to preserve the real value (adjusted for Harvard’s expense growth) of the endowment and its income distribution in perpetuity”. In recent years, the payout ratio (Endowment spending as a % of total Endowment value) has had a target range of 4.5% to 5.0%. In the case’s example, the average growth rate of Harvard’s expenses is 3% above CPI inflation rate and annual gifts to the endowment average about 1.5%. Hence, with a payout ratio target of 4.75%, we would get an Expected Return of 6.25%: 4.75% + 3% - 1.5% = 6.25% Q2. The Policy Portfolio is the “neutral” guide of long-term asset allocation set by the HMC board and it serves as a benchmark of actual performance and as a metric against which compensation of portfolio managers is measured. The aim of the Policy Portfolio is to provide targets for different asset categories as a percentage of the total portfolio, in order to achieve a long-term expected return with the least risk possible. The policy portfolio is reviewed every year and it is modified as a result of changes in market conditions, needs for long-term expected returns, and risk aversion. Jack Meyer’s vision was to keep the actual asset mix “fairly” close to the Policy Portfolio. Fairly close means that the Policy Portfolio included a minimum and a maximum percentage...
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...Inflation Tutorial http://www.investopedia.com/university/inflation/ Thanks very much for downloading the printable version of this tutorial. As always, we welcome any feedback or suggestions. http://www.investopedia.com/contact.aspx Table of Contents 1) Inflation: Introduction 2) Inflation: What Is Inflation? 3) Inflation: How Is It Measure? 4) Inflation: Inflation And Interest Rates 5) Inflation: Inflation And Investments 6) Inflation: Conclusion Introduction During World War II, you could buy a loaf of bread for $0.15, a new car for less than $1,000 and an average house for around $5,000. In the twenty-first century, bread, cars, houses and just about everything else cost more. A lot more. Clearly, we've experienced a significant amount of inflation over the last 60 years. When inflation surged to double-digit levels in the mid- to late-1970s, Americans declared it public enemy No.1. Since then, public anxiety has abated along with inflation, but people remain fearful of inflation, even at the minimal levels we've seen over the past few years. Although it's common knowledge that prices go up over time, the general population doesn't understand the forces behind inflation. What causes inflation? How does it affect your standard of living? This tutorial will shed some light on these questions and consider other aspects of inflation. (Page 1 of 7) Copyright © 2010, Investopedia.com - All rights reserved. Investopedia.com – the resource for investing and personal...
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...On 31st October 2014, with the historical move of ending the bond buying program of the US Federal Reserve after 5 years, Japan started off with yet another monetary stimulus program. Japan has been suffering from a deflationary trap for the past 2 decades. Hence, the bank aims to buy more assets this year in order to bring back the economy on the right path. Quantitative Easing is the unconventional supply of money in the economy by the Central Bank by buying assets from the commercial banks thus put money in the hands of the people. Most of the economies have a target inflation rate which needs to be maintained and if the rate falls much below the target, the economy can fall into a deflationary trap like Japan. Japan’s Quantitative-Easing Program: Japan has seen development and economic prosperity in the initial period of 1980s which turned out to be a scenario where the banks were lending money to the people without keeping a check on the borrower’s credibility. This led to the creation of a bubble and as a measure they increased the inter-bank lending rates and the bubble burst. Since the burst the economy has remained in a stagnant phase. This led to the creation of ‘Zombie Firms’ (firms which need constant bail-outs for their existence and operations) which is said to be responsible for the long stagnation of the country. The banks and financial institutions were constantly funded because the government thought these banks were ‘Too Big to Fail’. ...
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...9 -2 1 1 -0 0 4 REV: MAY 30, 2012 ANDRÉ PEROLD ERIK STAFFORD Harvard Management Company (2010) In February 2010, Jane Mendillo gazed out of her 16th-floor office window at a cold Boston Harbor and reflected on the set of issues facing Harvard Management Company (HMC). Since her return to HMC as CEO in July 2008, Mendillo had successfully managed the endowment through the worst financial markets crisis in a generation. But that period had brought to the fore multiple issues facing Harvard’s endowment, and she wanted the lessons from the crisis to inform the decisions at the HMC board’s next meeting. The board members would soon be reviewing its policy portfolio along with the current positioning of the endowment. They were eager for an update on a variety of related issues, highlighted during the crisis, such as the allocation of the endowment between internal and external managers, the illiquidity of much of the endowment, the effectiveness of HMC’s risk controls, and coordination with the university regarding its liquidity needs and risk tolerance. The Role of the Endowment Harvard University had been founded in 1636, and from the beginning its endowment played an important role in the financial structure of the institution. As of June 2009, the endowment totaled $25 billion. Each school within the university owned units in the endowment, much like an individual would own shares in a mutual fund, and received distributions from the endowment (“spending”)...
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