Financial Risk Manager Part 2
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In the context of fixed-income portfolio management, the portfolio manager is evaluating various techniques used for risk measurement, including principal mapping, duration mapping, and cash-flow mapping. With this in mind, which of the following options accurately represents the mechanics and outcomes associated with these risk measurement techniques?
In the context of fixed-income portfolio management, the portfolio manager is evaluating various techniques used for risk measurement, including principal mapping, duration mapping, and cash-flow mapping. With this in mind, which of the following options accurately represents the mechanics and outcomes associated with these risk measurement techniques?
Explanation:
D is correct. With duration mapping, a portfolio is replaced by a zero-coupon bond with maturity equal to the duration of the portfolio. This method simplifies the risk analysis by considering the portfolio's exposure to interest rate risk through its duration, which is a measure of the portfolio's sensitivity to changes in interest rates. A is incorrect because cash-flow mapping groups cash flows into maturity brackets, not by size. B is incorrect as cash-flow mapping uses the appropriate zero-coupon rate as the discount factor, not the average rates in each risk group. C is incorrect because principal mapping only considers the timing of redemption payments and does not account for correlations among zero-coupon bonds with different maturities, which is a feature of cash-flow mapping.