Abstract

Central banks around the world regularly change the benchmark policy rates not only to target inflationary spikes but also to ensure strong economic growth. But these changes in the benchmark rates effect the bond markets and the performance of the bonds as the bond yields and bond prices changing. This poses a challenge to the bond fund manager who regularly has to reshuffle the portfolio in order to achieve the goals of the fund and achieve better performance. The case discusses the various factors which influences the central bank’s decision to change the benchmark policy rates. The relationship between interest rates and bond prices and how the performance of bond funds is related to changing interest rate scenarios is brought out. The case also emphasises on how bond fund managers change duration of fund portfolios in anticipation of changes in interest rates in order to maximize the return on investment of the investors.

Learning Objectives

The case is structured to achieve the following Learning Objectives:

• To discuss the various global and domestic factors that influence India’s central bank, Reserve Bank of India’s (RBI’s) decision on policy rates and resultant effect on bond yields.
• To understand the relationship between bond prices and interest rates (yields) and also understand which bond yield measure is practically used and its limitations
• To discuss the difference between bonds maturity and its duration, also the various ways of understanding duration and to emphasize on how duration serves as measure of interest rate sensitivity
• To discuss how duration matching rather than maturity matching is more important to ensure the investment value is immunized to interest rate fluctuations.
• To discuss how the concept of duration is applied by the fund managers in anticipation of interest rate changes to rebalance their bond portfolios so as to enhance yields and consequences of failure to predict interest rate movements with reasonable accur

Keywords

Duration; Duration Management; Wealth Management; Capital Gains; Interest Rates; Bond Prices; REPO; Reverse REPO; CRR; SLR; Interest Rate Sensitivity; YTM; Maturity; RBI; Monetary Policy