Donald McKay, CFA, is analyzing a client's fixed income portfolio. As of the end of the last quarter, the portfolio had a market value of $7,545,000 and a portfolio duration of 6.24. McKay is predicting that the yield for ali of the securities in the portfolio will decline by 25 basis points next quarter. Which of the following statements regarding the portfolio's performance next quarter is most accurate?
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A. B. C.Explanation
To determine the portfolio's performance next quarter, we need to analyze the impact of the expected decline in yields on the portfolio's value.
Option A states that for the expected change in portfolio yield next quarter, the market value of the portfolio will change by approximately 6.24%. This statement is incorrect because duration measures the percentage change in the market value of a fixed income portfolio for a 100 basis point (1%) change in yield. Therefore, a 25 basis point (0.25%) change in yield would result in a market value change of approximately (6.24% * 0.25%) = 1.56%, not 6.24%.
Option B states that if the yield curve has a 50 basis point downward parallel shift next quarter, the portfolio will increase in value by approximately $235,404. This statement is not directly related to the expected decline in yields by 25 basis points. A parallel shift in the yield curve affects the value of fixed income securities, but it is not mentioned in the question. Therefore, this statement cannot be determined or verified based on the information provided.
Option C states that the portfolio's ending value after the expected decline in yields will be approximately $7,427,298. To determine the portfolio's ending value, we need to calculate the change in market value caused by the expected decline in yields. The formula to calculate the change in market value is as follows:
Change in Market Value = - Portfolio Value * Portfolio Duration * Change in Yield
Given the portfolio's market value at the end of the last quarter is $7,545,000 and the portfolio duration is 6.24, and the expected decline in yield is 25 basis points (0.25%):
Change in Market Value = - $7,545,000 * 6.24 * 0.0025 = -$47,156.25
The negative sign indicates a decrease in market value due to the decline in yields. Therefore, the portfolio's ending value after the expected decline in yields is:
Ending Value = Portfolio Value + Change in Market Value = $7,545,000 - $47,156.25 ≈ $7,497,843.75
Option C states that the portfolio's ending value will be approximately $7,427,298, which is not consistent with the calculations above. Thus, option C is not the most accurate statement.
In conclusion, the most accurate statement regarding the portfolio's performance next quarter is option B. However, it should be noted that option B is not directly related to the expected decline in yields of 25 basis points mentioned in the question.