Portfolio management problems can be viewed as multi-period dynamic decision problems where transactions take place at discrete points in time. At each point in time the manager has to assess the prevailing market conditions – such as prices and interest rates – and the composition of the existing portfolio. The manager also has to assess possible future movements of interest rates, prices, risk premia, and cashflows from the securities. This information is incorporated into a sequence of buying or selling actions, and short-term borrowing or lending decisions. At the next point in time the portfolio manager has at hand a seasoned portfolio and is faced with a new set of possible future movements. Transactions must now be executed that incorporate the new information.
For fixed-income securities the key portfolio management strategy has been that of portfolio immunization: portfolios are developed that are hedged against small changes from the current term structure of interest rates (Zenios et al, 1998).
Critically discuss the advantages and disadvantages of the above mentioned portfolio management strategy and critically evaluate the usefulness of alternative strategies available to manage fixed income portfolios.
