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Group 12: Chao Wu, Divya Rathi, Kenneth Chua, Yang Liu, Adrien Gabeur
Case Summary Key Assumptions and Identified Problems Analysis Why are investors keen on long-term bonds? A number of investors have long-term liabilities, such as pensions and insurance companies. They need long duration assets to reduce their asset/liability mismatch. While a 100-year bond exposes one to rising rates, the long-term liabilities will have an offsetting effect. A 100-year bond has tremendous convexity. And being long convexity is sometimes worth taking a lower yield. A 100-year bond will significantly outperform a 10-year bond for example if yields compress. It will underperform but to a much lesser extent if yields rise by the same amount. Convexity gives investors a cushion against rate volatility.
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Exhibits
Dimensional Management Assumption about the market Trading Strategy Market works Captures specific dimensions of risk identified by financial science Minimizes transaction costs and enhances returns through portfolio design and trading Active Management Market dont work Attempts to beat the market through security selection and market timing Generates higher turnover, transaction cost, and taxes due to speculative trading Index Management Market works with no liquidity cost Allows commercial benchmarks to dictate strategy Accepts high transaction costs and turnover in favor of tracking
Transaction costs
Russell Midcap Russell Midcap Value Index Russell 2000 Value Index Russell 2000 Russell 3000