Stable value pooled funds:
Scenarios for rising rates
and cash outflows
Vanguard research
Executive summary. Stable value funds provide a low-volatility option for
many defined contribution benefit plans. Over the longer term, returns
have been above those of money market investments because of the
longer duration of the assets backing the stable value investment contract.
Although stable value funds in general have performed well through past
market cycles and crises, in the current environment of low interest rates
both stable value investors and contract providers have been concerned
about the effect rising interest rates would have on the funds and the
ability of the funds to continue to perform well when further stressed by
cash outflows.
In our analysis, we considered two plan withdrawal scenarios for
commingled, or pooled, stable value funds, in the context of one of the
most pronounced rising-rate periods in the United States since the 1980s.
We calibrated these adverse scenarios with the present low nominal U.S.
Treasury yields in order to analyze the impact on the funds’ market value/
book value ratios.
Connect with Vanguard > vanguard.com
June 2012
Authors
Steve Xia, Ph.D., CFA
Susan Graef, CFA
Mark Dorfler
Michael Montanez
Although stable value investments, like bonds, are subject to credit, income,
inflation, event, and market risks, in our simulations, the funds’ MV/BV ratios
demonstrated resiliency, and crediting rates fluctuated within a band far
narrower than that of market yields, even in extraordinary scenarios.
Since the 2007–2009 credit crisis, stable value
contract providers have become increasingly
concerned about a participating plan’s option to
withdraw from a commingled, or pooled, fund at
book value with 12 months’ notice. This feature is
often referred to as a “12-month put.” In particular,
providers have been concerned about the effect
this feature would have on market value/book
value (MV/BV) ratios and crediting rates.
In our study, we first considered the impact of a
severe increase in interest rates on the price return
of stable value funds, using one of the more severe
shifts in the U.S. Treasury yield curve following
tightening by the Federal Reserve in the recent
past. (Although credit spreads tend to narrow as the
Fed tightens, or raises interest rates, we made the
more conservative assumption that spreads stayed
the same.)
We then assumed that a certain percentage of plan
sponsors exercised their “put,” which enables them
to receive their plan balances in 12 months, when
certain event triggers are tripped. We considered
two scenarios: when the yields for money market
funds approached those of stable value funds, and
when the market value of a stable value fund’s
underlying assets was less than the book value. As
an additional conservative measure, we assumed
that assets were paid out of the fund, at book value,
the following month, rather than 12 months later.1
We were interested not only in how much stress the
stable value portfolios would experience as interest
rates rose, but also to what extent MV/BV ratios
would recover—that is, reach 100%—following the
peak of rates, and chose a 12-month follow-up
period. We also wanted to see whether crediting
rates would remain relatively stable, reflecting the
performance of the underlying fixed income
investments, albeit at a lag.
We used Vanguard’s pooled fund, the Vanguard
Retirement Savings Trust, for our scenario analysis,
based on the characteristics of the trust as of
November 30, 2011. Both of the withdrawal
scenarios we considered represented more adverse
conditions than the VRST has ever experienced.
With the average duration of underlying
investments at approximately 2.6 years, we used
the key rate durations (KRD) of the portfolio at
points along the Treasury curve to compute more
precisely the investments’ price sensitivity to shifts
in the yield curve.2
Notes on risk: All investments are subject to risk. Investments in bonds are subject to interest rate, credit,
and inflation risk. Foreign investing involves additional risks, including currency fluctuations and political
uncertainty. Diversification does not ensure a profit or protect against a loss in a declining market. Past
performance is no guarantee of future returns. The performance of an index is not an exact representation
of any particular investment, as you cannot invest directly in an index.
1 This assumes that a plan is taking advantage of withdrawing at a book value greater than market value, and moves to a new investment that is realizing a
higher yield, such as an intermediate-term bond fund.
2 We believe the characteristics of the Vanguard Retirement Savings Trust to be average to above average for the industry. Commingled stable value funds
will vary in terms of MV/BV ratios, effective yields, key rate durations, and the convexity of their underlying investments.
2
The study looked to the actual shift in the yield curve
during the periods when the Federal Reserve was
raising the federal funds rate. In general, the rates at
the longer end of the yield curve did not increase by
as much as rates at the shorter end (that is, the
shifts were non-parallel), and the impact was not as
severe when using the actual KRDs as when using
the portfolio’s average duration.
We modeled the overall yield of the underlying
investments to follow the Treasury rate change on a
duration-weighted basis. Initial MV/BV ratios were
based on the VRST. Crediting rates were reset
monthly, using the formula shown in the
accompanying text box.3
Although the dollar-weighted average maturity of a
money market fund will be 60 days or less, we used
the 12-month Treasury yield as a proxy for money
market yields, in place of the 3-month Treasury
yield, because money market funds may also invest
in securities other than Treasuries, providing
additional yield.
The base case: Rising interest rates
Selecting the interest rate stress test
First we looked at what would happen if the
Fed were to raise rates as severely as it has in
recent history.
We excluded the late 1970s, a time of double-digit
inflation, because the conditions that existed then
are unlikely to occur in the near term (see the
accompanying box on page 4). The two other most
Stable value fundamentals:
The crediting rate
Wrap contracts backed by diversified fixed
income investments represent the core of
stable value funds. A stable value fund’s
earnings are determined by the crediting rate,
which is specified in advance and is used to
amortize market value gains and losses of the
fixed income investments. The formula for the
crediting rate is:
Crediting rate = (1+ Yield) * (MV/BV)^(1/D)
where the yield is the effective yield of the
underlying fixed income investments, MV is
the market value of the underlying
investments, BV is the book value of the stable
value fund, and D is the effective duration of
the underlying investments.
Participant cash flows, and certain other
payments permitted by the wrap contract, can
also affect the crediting rate because these
cash flows are paid at book value.4 One
category of “other” payments is when a plan
withdraws from a collective stable value fund
(in which a number of plans invest) after
providing 12 months’ notice. This 12-month put
feature is receiving increased attention from
wrap providers because of their obligation to
pay the difference when the fund’s book value
exceeds the market value.5
3 Typically, crediting rates are reset quarterly; resetting quarterly had an insignificant impact on the volatility of crediting rates, and no impact on MV/BV
ratio minimums.
4 For MV/BV ratios of less than 100%, participant withdrawals will worsen the MV/BV ratio. For example, if MV = $100, and BV = $105 (for an MV/BV ratio
of 95.2%), then following a $10 participant withdrawal, the MV = $90, the BV = $95, and the MV/BV ratio declines to 94.7%.
5 Wrap contract providers’ financial exposure increases as the MV/BV ratio declines, although an actual outlay occurs only when book value payments
exceed the entire market value of the contract. Market value is not restored by the wrap provider on partial book value payments.
3
Figure 1.
Federal funds rate, July 1954 through March 2012
20%
’86–’89
’04–’07
15%
10%
5%
0%
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Source: Federal Reserve.
Stable value funds and high inflation
The interest rate environment of the late 1970s
was the most severe in recent history, with the
Federal Reserve increasing the federal funds rate
in an effort to combat inflation. A scenario based
on that time, in which the investment
characteristics of the underlying investments
were held constant, would result in MV/BV ratios
at levels meaningfully below those in this analysis.
If cash outflows were to occur at these MV/BV
ratios, crediting rates would fall toward or reach
the contract floor of 0%. This increases the risk to
the contract issuer. In the event that all assets
were withdrawn, the issuer could be exposed to
making a payment to cover the difference between
the market value and book value. (In practice, there
4
are mitigating actions that probably would be taken
in response to market conditions and cash flow
patterns, such as shortening the duration of the
underlying investments.)
Why not consider this scenario? According to
Vanguard’s Economic and Investment Outlook
(Davis and Aliaga-Diaz, 2012), the probability that
the inflationary environment of the 1970s and
early 1980s will be repeated over the next several
years is estimated to be less than 10%. Although
an interest rate scenario based on the 1986–1989
period is more severe than the expected range of
future yields over the next 10 years, the
conditions of that period are more likely to occur
than the 1970s environment.
Figure 2.
Changes in the U.S. Treasury yield curve during pronounced periods of rising interest rates
a. 1986–1990
b. 2004–2008
8%
8%
6%
6%
Yield
10%
Yield
10%
4%
4%
2%
2%
0%
0%
3-mo
1
2
3
5
7
10
15
20
25
30
Maturity (in years)
Beginning curve—October 31, 1986
Peak curve—March 31, 1989
Recovery curve—March 31, 1990
3-mo
1
2
3
5
7
10
15
20
25
30
Maturity (in years)
Beginning curve—January 31, 2004
Peak curve—February 28, 2007
Recovery curve—February 28, 2008
Source: Federal Reserve.
severe periods of rising rates were 1986–1989 and
2004–2007 (Figure 1, on page 4). We selected
1986–1989 because the decline in price return
across the yield curve was greater. During this
period, the yield of the 10-year U.S. Treasury rose by
approximately 190 basis points. As of mid-February
2012, based on the forward Treasury yield curve,6
the bond market expected the 10-year Treasury yield
to rise from 1.9% to 2.8% by 2017, or about 100
basis points less than it did in the 1986–1989 period.
Also of note is that in the 12 months following the
tightening, yields did not return to their pretightening levels, as they did for the 2004–2007
period (Figure 2).
To calculate the impact on the underlying
investments during a period of rising rates, we
applied the yield curve shift that occurred in 1986–
1989, and for the 12 months afterward, to the
current term structure of the stable value portfolio’s
underlying investments, projecting the impact over
the same length of time and at the same rate of
change.7 We used yields as of November 2011
(when they were at very low nominal levels) as the
starting point, and assumed that there were no
changes to the underlying investments’ key rate
durations. This resulted in an increase in the
12-month Treasury yield of 385 basis points (3.85%)
and an increase in the effective yield of the
underlying investments of 275 basis points through
the simulated tightening. (In the 12 months posttightening, the Treasury yield declined by 122 basis
points and the effective yield by 92 basis points.)
These statistics were used to calculate hypothetical
market values, book values, and crediting rates
through May 2015.
6Bloomberg.com.
7 Key rate durations, on a percentage contributions basis, for the Vanguard Retirement Savings Trust were as follows: 3 months, 0.9%; 1 year, 8.0%; 2 years,
22.3%; 3 years, 15.9%; 5 years, 16.7%; 7 years, 15.2%; 10 years, 10.6%; 15 years, 4.9%; 20 years, 2.7%; 25 years, 1.5%; 30 years, 0.4%.
5
Figure 3.
Impact of 1986-1989 change in the U.S. Treasury yield curve projected from November 2011
Projected crediting rates remain relatively stable, and MV/BV ratios generally remain above 98% through the rising-rate scenario.
November 2011 through May 2015
110%
5%
4%
105%
3%
100%
2%
98%
95%
1%
90%
0%
2012
2013
2014
2015
Base case, crediting rate (left scale)
Effective yield of investments underlying the stable value fund (left scale)
Base case, MV/BV ratio (right scale)
Source: Vanguard.
Effect of rising rates
As shown in Figure 3, the MV/BV ratio starts at
104.61%, the MV/BV ratio for the VRST as of
November 30, 2011. In the simulation, it declines to
97.08% at the end of the simulated Fed tightening
in May 2014, before recovering to over 100% in the
following three months, and remains at or above
100% through the remaining nine months of the
analysis. The recovery to 100%, or “par,” is
important because the potential exposure of the
fund’s wrap providers increases any time the
market value of the investments underlying the
stable value contracts is below the book, or
contract, value.
The crediting rate fluctuates within a band of
approximately 2.90% to 3.30%, far narrower than
the simulated change in interest rates.
Underlying the MV/BV recovery are the cumulative
returns of the underlying investments plotted in
Figure 4. Although the increase in interest rates
6
has a negative impact on the price return (which
drops to a cumulative low of –7% by the end of the
simulated Fed tightening in May 2014), the
cumulative total return is positive over this period,
owing to the time it takes for rates to rise to their
peak and the support of interest earnings. The
stable value fund’s ability to withstand rising
interest rate environments depends on both the
overall change in rate levels and the period over
which the rise occurs. As shown in Figure 5, the
crediting rate initially trends lower as rates rise, but
levels off as the cumulative returns provide support
later in the cycle.
Generally, the interest rates of longer-term bonds
will not rise to the same extent as shorter-term rates
during periods of Fed tightening. In the simulation,
based on what occurred in 1986–1989, the spread
between the 12-month Treasury yield (the money
market proxy) and the effective yield for the
investments underlying the stable value fund (which
had a starting value of 1.55%) widened from 144
Figure 4.
Contribution of cumulative returns in rising-rate environments: Impact on the MV/BV ratio
The MV/BV ratio is supported by the cumulative return of the underlying investments over time.
Projected from November 2011 through May 2015
110%
15%
10%
105%
5%
100%
0%
95%
–5%
90%
–10%
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Cumulative income return (left scale)
Cumulative price return (left scale)
Cumulative total return (left scale)
Base case, MV/BV ratio (right scale)
Source: Vanguard.
Figure 5.
Contribution of cumulative returns in rising-rate environments: Impact on the crediting rate
The cumulative total return of the underlying investments also supports the stability of the crediting rate as interest rates change.
Projected from November 2011 through May 2015
8%
7%
6%
5%
4%
3%
2%
1%
0%
–1%
–2%
–3%
–4%
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Base case crediting rate
Effective yield
Cumulative total return
Source: Vanguard.
7
Figure 6.
Comparison of yields and rates: Base case
Money market yields are more responsive to changes in interest rates and outpace the crediting rate for several months.
Projected from November 2011 through May 2015
5%
4%
3%
2%
1%
0%
–1%
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Base case crediting rate
Effective yield
Money market proxy: 12-month Treasury yield
Crediting rate vs. money market proxy
Source: Vanguard.
basis points at the beginning of the simulation to
166 basis points midway through the simulated
tightening, before narrowing to 35 basis points at
the end of the simulated tightening. As shown in
Figure 6, the crediting rate reflects the change in
yields at a much slower rate, and within a tighter
band, causing the yield of the money market proxy
to temporarily exceed the crediting rate.
(with such plan-level withdrawals subject to the
12-month put), but to be conservative, the following
test assumes that some plan sponsors will terminate
their stable value fund when its yield exceeds money
market fund yields by less than 50 basis points. We
assumed that each time this criterion was met, 5%
of plans withdrew from the stable value fund, with
no offsetting inflows.
Stress-testing with cash flows
Although such withdrawals at a plan level generally
require 12 months’ notice, to be conservative, we
assumed the money left the stable value fund the
month after the yields compressed. As the starting
book value, we used the book value of the VRST as
of November 30, 2011, which was approximately
$19 billion, and withdrawals are shown on a dollar
basis or as a percentage of the fund’s prior month’s
ending book value. We used the VRST’s MV/BV ratio
of 104.61% as the starting ratio.8
Scenario 1: Simulating withdrawals
based on relative yields
The first scenario assumes that plan sponsors could
decide to move their plans out of a stable value
investment when the yields of money market funds
get close to those of stable value funds, which carry
moderately more risk. A plan sponsor will consider
many factors before changing investment options
8 The MV/BV ratio of the Vanguard Retirement Savings Trust is currently above the average, as represented by the Hueler Analytics Stable Value Pooled Fund
Universe. Funds with MV/BV ratios meaningfully below the MV/BV used in this study would be less likely to return to par under the simulated stress tests.
8
We assumed that money market yields, starting at
11 basis points (the actual 12-month Treasury yield
as of November 30, 2011), matched the movement
of the 12-month Treasury yield for the 1986–1989
period, plus the following 12 months.
In this scenario, the yield of the stable value fund
exceeded that of the money market proxy by less
than 50 basis points 11 times, including a period of
eight consecutive months.
Using this withdrawal decision scenario, approximately
38% of the stable value fund’s assets would have
been withdrawn in a 14-month period, a significantly
greater percentage than that experienced by the VRST
during historical rising-rate environments.9
In this simulation, the crediting rate reached a low
of 2.87% midway through the tightening, trended
up to 2.91% at the conclusion of the tightening in
Figure 7.
May 2014, and reached 3.02% 12 months later
(Figure 7). The MV/BV ratio reached a minimum of
96.52%, and increased back to par four months later,
based on the projected market yields. As Figure 8,
on page 10, shows, the cash outflows directly affect
the MV/BV ratio, with recovery following the
cumulative total return of the underlying assets.
Scenario 2: Simulating withdrawals
based on the MV/BV ratio
The 12-month put feature typical for pooled stable
value funds provides for the payment of plan
participants’ balances at book value with 12 months’
notice. When the market value of the underlying
assets is less than the book value of the assets (that
is, the MV/BV ratio is less than 100%), the plan will
receive a premium over the market value of the
assets. Again, a plan sponsor’s decision to convert a
stable value fund to a different option will be based
Withdrawals based on relative yields: Impact on the crediting rate
Amid cash outflows, the crediting rate remains relatively stable.
Projected from November 2011 through May 2015
$0
5%
–$200
4%
–$400
–$600
2%
–$800
1%
0%
$ Millions
3%
–$1,000
–$1,200
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Crediting rate (left scale)
Money market proxy: 12-month Treasury yield (left scale)
Cash flows (right scale)
Note: For cash flows, we assumed that 5% of plans withdrew from the stable value fund when its yield exceeded that of the money market proxy by less than 50 basis points.
Source: Vanguard.
9 The inception date of the VRST was January 1989, but looking at the rising-rate environment from January 2004 through February 2007, the average
monthly net cash flow was 0.49% of VRST assets, and the cumulative net inflow was 18.6%. The single largest monthly net outflow was -2.60%. The
yields of the VRST and of the Investor Shares for Vanguard Prime Money Market Fund were within 50 basis points of each other from October 2005 through
January 2008. During that time, the average monthly net cash flow, as withdrawals were offset by contributions and exchange activity, was 0.33% of VRST
assets, with a cumulative net inflow of 9.3% for the entire 28-month period. The single largest monthly net outflow was -2.60%.
9
Figure 8.
Withdrawals based on relative yields: Impact on the MV/BV ratio
The MV/BV ratio is supported by the cumulative return of the underlying investments over time, even with cash outflows.
Projected from November 2011 through May 2015
110%
10%
8%
6%
105
4%
2%
0%
100
–2%
98%
–4%
95
–6%
–8%
–10%
90
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Crediting rate (left scale)
Cumulative total return (left scale)
Cash flow as percentage of prior month’s balance (left scale)
MV/BV ratio (right scale)
Source: Vanguard.
on several factors, but to be conservative, we
assumed for this scenario that when the MV/BV fell
below 98%, 10% of plans would transact on this
information the following month.
Using the same interest tightening base case, with
the same starting MV/BV ratio used for the other
simulations, this criterion was met six times during
the peak of the tightening (Figure 9).
Under this withdrawal scenario, the book value of
the fund assets (again, from a starting value of $19
billion) would have declined by 43% owing to
withdrawals occurring over a six-month period,
which would be a severe and extraordinary event.
During this simulation, the MV/BV reached a
minimum of approximately 96%.10
Yet, even with this substantial withdrawal activity,
the decline in interest rates following the peak of the
tightening resulted in an improvement of the MV/BV
ratio to over par initially in six months, even as
withdrawals continued.
Predictably, the crediting rate reached its low for
the simulation when the MV/BV was also at its
low point; however, the crediting rate remained
within a range of 2.60% to 3.31% (Figure 10).
The relative stability of the crediting rate, as was
the case in the other scenarios, is mostly the result
of the cumulative income earnings over time,
which offset the price decline for the simulated
underlying investments.
10In fact, from June 2008 through June 2009, when industry average MV/BV ratios (as represented by the Hueler Analytics Stable Value Pooled Fund
Universe) were less than 98%, assets in the VRST increased by approximately 9% as investors sought relief from falling equity markets.
10 Figure 9.
Withdrawals based on the fund’s MV/BV ratio
The MV/BV ratio recovers from the impact of cash outflows.
Projected from November 2011 through May 2015
110%
$0
$ Millions
–500
105
–1,000
100
98%
–1,500
95
–2,000
90
–2,500
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Cash flows (left scale)
MV/BV ratio (right scale)
Note: For cash flows, we assumed that 10% of plans withdrew from the stable value fund when the MV/BV ratio fell below 98%.
Source: Vanguard.
Figure 10.
Withdrawals based on the fund’s MV/BV ratio: Crediting rates, MV/BV ratios and cumulative returns
The crediting rate remains relatively stable as the cumulative total return supports the MV/BV ratio recovery.
Projected from November 2011 through May 2015
110%
10%
105
5%
100
0%
95
90
–5%
Jan. 2012
July 2012
Jan. 2013
July 2013
Jan. 2014
July 2014
Jan. 2015
Crediting rate (left scale)
Cumulative total return (left scale)
MV/BV ratio (right scale)
Source: Vanguard.
11
Conclusion
The test scenarios in this analysis were based on
past market cycles and were designed to be very
stressful and to isolate the effects of the scenarios
on stable value funds. In actual experience,
participants and plan sponsors act based on the
economic environment’s impact across all their
investment options. (This was evident during the
credit crisis when widening credit spreads drove
down MV/BV ratios, but cash flowed into stable
value funds in a “flight to safety” from the volatility
in equity and other marked-to-market funds.)
The potential competition from money market and
short-term bond yields, which will be present from
time to time, is reduced by the relative stability of a
stable value fund’s crediting rate, which reflects
fluctuations in current market yields more slowly.
Although Fed tightening will have a direct impact on
shorter-term rates, historically such tightening has
had less of an effect on longer-term rates. For this
reason, the analysis shows that the impact of risingrate environments is not as negative as when a
parallel shift in rates across the curve is used. (We
did not assume a parallel shift would occur because,
based on the bond market’s upwardly sloping yield
curve, the Treasury yield curve is expected to
12 exhibit a “bear flattening” over the next several
years, with short-term rates rising more than those
for longer-maturity bonds.) In addition, tightening
takes place over time, enabling income earnings to
offset capital losses.
These scenarios demonstrate that under
extraordinary conditions, the stable value model
provides for the recovery of the market value of the
underlying investments to 100% of the portfolio’s
book value, and a crediting rate that fluctuates within
a band far narrower than that of market yields.
Like all investments, there are risks associated with
stable value funds that may not fit with certain plan
sponsors’ and participants’ investment goals and
objectives. Nonetheless, an understanding of the
impact on stable value funds of adverse market
conditions and adverse cash flow activity is
important in fully understanding the risks associated
with the asset class.
There are many scenarios other than the ones we
selected that may be constructed, and we hope this
paper will provide not only helpful observations on
the strengths of the stable value model, but also a
framework for the analysis of other stress tests.
Figure 11.
Summary of scenarios
a. MV/BV ratios in given scenarios
b. Crediting rates in given scenarios
Projected from November 2011 through May 2015
Projected from November 2011 through May 2015
105%
4%
3%
100%
2%
1%
0%
95%
2012
2013
2014
2015
2012
Base case
Relative yield scenario
MV/BV scenario
2013
2014
2015
Base case
Relative yield scenario
MV/BV scenario
c. Detailed results
Projected from November 2011 through May 2015
MV/BV high
MV/BV low
Crediting
rate high
Crediting
rate low
Base case
104.61%
97.08%
3.31%
2.87%
Relative yield scenario
104.61%
96.52%
3.31%
2.87%
MV/BV scenario
104.61%
96.12%
3.31%
2.60%
Source: Vanguard.
13
References
Bond yield measures
Davis, Joseph, and Roger Aliaga-Diaz, 2012.
Vanguard’s Economic and Investment Outlook.
Valley Forge, Pa.: The Vanguard Group.
Yield: The return earned on a bond, expressed as an
annual percentage rate.
LaBarge, Karin P., 2009. Stable Value: A Closer Look
at This Hybrid Fixed Income Strategy. Valley Forge,
Pa.: The Vanguard Group.
LaBarge, Karin P., 2011. Stable Value: Navigating
Past the 2008 Credit Crisis. Valley Forge, Pa.:
The Vanguard Group.
Yield-to-call (YTC): The rate of return received if the
bond is held to its call date and redeemed at its call
price. YTC assumes interest payments are
reinvested at the yield-to-call date.
Yield-to-maturity (YTM): The rate of return received
if a bond is held to maturity and interest payments
are reinvested at the YTM rate. YTM is the discount
rate at which the present value of future payments,
including interest income and return of principal at
maturity, equals the price of the security.
Yield-to-worst (YTW): The lower of yield-to-call and
yield-to-maturity, given the potential stated calls prior
to maturity.
Duration: The approximate percentage change in
value for a 100-basis-point (1.00%) change in rates.
Effective duration (also known as option-adjusted
duration): A duration calculation for bonds with
embedded options. Effective duration takes into
account that expected cash flows will fluctuate as
interest rates change.
Key rate durations (KRDs): Measure a bond’s or
portfolio’s price sensitivity to independent shifts
along the yield curve at selected “key” points. KRDs
are computed by decreasing or increasing each
individual key spot rate by some number of basis
points and re-computing the bond’s or portfolio’s
price given that shift, holding all other spot rates
along the term structure constant. The average
percentage change in the asset’s value resulting
from a given pair of key rate shifts is its KRD for that
point on the curve. The sum of these “partial”
durations is the asset’s overall effective duration.
14 15
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An investment in a money market fund is not insured
or guaranteed by the Federal Deposit Insurance Corporation
or any other government agency. Although a money market
fund seeks to preserve the value of your investment at
$1 per share, it is possible to lose money by investing in
such a fund.
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ICRSVP 062012