Question-66: Few of things can you tell, which are considered while creating bond indexes?

Answer: Several characteristics are critical in judging or composing bond indexes.

• Sample of securities/bonds or issues
• Maturity of the issue
• Size of the issue
• Weighting of returns for individual issues.
  • Returns market-value weighted
  • Or equally weighted
• Quality of Price Data: Portfolio managers who uses the indexes need to consider the quality of the price data used in the computation is this estimated prices or actual transaction prices.
• Prices are based on matrix pricing, like it involves computer model which estimates a price using current and historical relationships.
• Reinvestment assumption does the rate of return calculation using the interim cash-flows.

Question-67: Do you know which firms publishes Bond Indexes for U.S. Investment-Grade Bond?

Answer: Four firms publish rate-of-return for investment-grade bond market indexes.

• Barclays Capital which has acquired Lehman Brothers.
• Bank of America-Merrill Lynch
• Morgan Stanley Smith Barney.
• Ryan Labs.

Question-68: What is the concern with the bond indexes composed based on weighting?

Answer: If bond indexes are composed using the market-value weighting is that

• Consider economic conditions and reflects it in the index.
• No preference: no preferences regarding asset allocation.

But the concern is that in real world it is difficult to keep track of the outstanding bonds, because of various options like below

• Call and Put provision
• Sinking funds provision
• Bond Redemptions.

Question-69: What are the advantages of the bond with equal weighting for an investor?

Answer:

• For investor or portfolio managers who has no prior assumptions of individual issues it is good.
• Consistent: Equal weighting is consistent if investor is assuming random selection of issues. –
• Easier to compute: An equally weighted index is easier to compute.

Question-70: What is the major problem with bond index computation?

Answer:

• Price: prices of the underline issues are not easily available. And that can be either trade’s bid price or matrix-based prices calculated using computer model.
• Reinvestment: It depend when the cash-flow received is re-invested. It can be either immediately (aggressive approach) or conservatively (not-immediately) or not at all re-invested. And if invested then where it is re-invested and what rate should be considered if re-invested.