A local lumber producer has contacted you regarding setting up their employee defined benefit pension plan. The duration of the pension liabilities is 10 years. The company pension fund has $10 million Canadian to invest in fixed income and they want you to invest this money according to the following criteria:
1. You can only invest in corporate, government, agency and municipal bonds.
2. Both U.S and Canadian bonds can be included in the portfolio.
3. At least 40% of the portfolio should be invested in government bonds-either U.S or Canadian.
4. The share of corporate bonds cannot exceed 25% of the portfolio.
5. All four kinds of bonds (corporate, government, agency and municipal) have to be included in the portfolio.
6. A 1% deviation is allowed under the initial portfolio value. This means you can start with between $9.9 million and $10.0 million.
Additionally, the company expects payouts to start about 5 years from now, so the portfolio must earn a "decent" amount of return for the next 5 years. They want the portfolio to be somewhat less sensitive to interest rate changes than the liabilities, but they did not explain the term "less sensitive", so be sure to explain how you addressed this in your final submission.
Your job is to recommend a structure for the $10 million bond portfolio. First, list the bonds you have selected, their prices, coupons, maturities, durations and convexities in a spreadsheet. Make sure that the prices you record include the accumulated interest, i.e., the dirty prices.
Last, but not least, justify your choice of bonds and your overall portfolio values within the context of projected economic conditions. This is not merely a number exercise-there has to be some discussion about the current situations and future prospects in the fixed income financial markets.
The project output has to include the following:
1. Introduction - this section will describe the project and include a discussion of the market conditions. Use no more than 250 words.
Discussion of the effects of the state of the economy, financial market conditions, industry (sector) on the fixed income securities selected in the portfolio.
2. Data - no matter what the final structure is, whatever bonds you looked at, all the raw data should be presented in an Excel worksheet.
The bonds need to be described (issuer, coupon, maturity) along with a bond rating, sector category and duration measure. The bond prices need to be given as well.
3. Proposed structure - after doing your permutations and combinations, whatever structure you come up with, present that for a layman. Whatever you present, it has to be in a word format. Use no more than 250 words.
Essentially the project needs to look professional.
4. Justification - in this section you will justify your proposed structure in light of the above guidelines. Use no more than 500 words.
Explain why you chose your bonds which may consider why you chose not to include other bonds.
5. Bibliography - you should clearly demonstrate the sources for your data. You must mention the date on which you collected the data from these sources. You should use the APA format when citing your sources.