In the evaluation of bond portfolio performance, the policy effect refers to
A) the difference in portfolio duration and index duration.
B) the extra return attributable to acquiring bonds that are temporarily mispriced relative to risk.
C) short-run changes in the portfolio during a specific period.
D) the differential return from changing duration of the portfolio during a specific period.
E) None of these are correct.

Question

Quizplus · Accepted Answer

The policy effect refers to the difference between the duration of the bond portfolio and the duration of the benchmark index used for comparison, which is often set by the investment policy of the investor. It measures the deviation of the actual portfolio from the target or desired exposure to interest rate risk, and can affect the returns of the portfolio relative to the benchmark. The other choices refer to other sources of return or risk in bond investing, such as market timing, credit risk, liquidity risk, or yield curve positioning, but they do not specifically relate to the policy effect.

In the Evaluation of Bond Portfolio Performance, the Policy Effect