Abstract
This chapter reviews the essentials of active management of a bond portfolio. Active portfolio management can be broken down into four basic categories. The first type is described as an expectations approach that is based on the expected direction of interest rates and that aims to gain from correctly calling changes in interest rates. A fund manager that wishes to position a portfolio to reflect his or her own views on the future level of interest rates will adjust the portfolio's sensitivity to changes in interest rates. Another method by which fund managers can undertake interest rate strategies is by using very rate-sensitive cash instruments. These include mortgage-backed bonds and bonds with embedded option features. The yield curve is a static representation of the dynamic term structure of interest rates. A shift in the yield curve will occur for a number of reasons, connected not just with the market's view on interest rates but also factors such as liquidity and supply and demand. For portfolio managers immunization risk is essentially reinvestment risk. This means that the portfolio with the lowest reinvestment risk will carry the lowest immunization risk.
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