(The) valuation model of floating rate securities and immunization strategy of bond portfolio

Abstract

This study derives the valuation model of floating rate securities and examine the immunization strategy of bond portfolio. Bonds have long been regarded as excellent vehicles for those seeking current income; it is only recently, with the advent of high and volatile interest rates, that they have also become recognized as excellent trading vehicles. As bonds have become more varied, the use of the instruments in a portfolio and their pricing have become more complicated. aothough progress and, in some cases, solutions have been developed for a number of practical and theoretical problems in bond portfolio management, many remain unsolved. Thus it is useful to tackle these unsolved problems in bond portfolio management. This study seeks the solutions for the three unsolved problems in bond portfolio management which are interesting to the investors. In chapter 2, we derive the valuation model of floating rate securities. Floating rate bonds are characterized by coupon rates that vary over time and reflect the prevailing interest rate. Since the coupon rates of floating rate bonds are determined by the history of interest rates to which the coupons are linked, the valuation of floating rate securities becomes path-dependent. This path-dependent property of floating rate bonds makes the valuation problem difficult. Chapter one of this study seeks the valuation model of floating rate bonds by extending the arbitrage-free interest rate movements (AR) framework of Ho and Lee(1986). The third chapter seeks a rebalancing discipline for an immunization strategy when there are transaction costs. "Immunization" against interest rate risk is said to exist if the total value of a default-and option-free bond or portfolio of bonds at the end of a specified investment period is equal to the value expected at purchase. The immunized portfolio must be adjusted frequently because the passage of time and changes in the interest rate do not the duration and the planning period eq...