The Harvard Management Company and Inflation-Protected Bonds
1(a) Regular Treasury bonds are purchased at face value in the beginning or an adjusted price prior maturity. And in every period, normally annul or semiannual, investor will receive a coupon as an interest and at the maturity a principal plus coupon. (b) Coupon and principal of the Regular Treasury bonds are fixed, therefore if the inflation rate increases in the forecasting future, investor will receive the same amount of coupon and principal with less real value and purchasing power. (c)TIPS are simultaneously related to change of inflation rate which means the principal and coupon will adjust instantly to change of inflation rate. TIPS like Regular Treasury bonds …show more content…

6(a) According to Exhibit 4, HMC expect TIPS has return of 4%, it has a standard deviation of 3% which is much lower than the average standard deviation 11.83%, so volatility is much lower compared to other asset class. The assumed correlation are | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Correlations | Infl-Indexed Bonds | Domestic Equity | | 0.10 | | Foreign Equity | | -0.05 | | Emerging Equity | | 0.00 | | Private Equity | | 0.10 | | Absolute Return | | 0.20 | | High Yield | | 0.30 | | Commodities | | 0.20 | | Real Estate | | 0.20 | | Domestic Bonds | | 0.50 | | Foreign Bonds | | 0.10 | | Infl-Indexed Bonds | | 1.00 | | Cash | | -0.10 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |

(b)We know the correlations of inflation-indexed bonds and other asset class (exhibit 4) and percentage of all asset classes in proposed portfolio, therefore we estimate correlation between TIPS and proposed Policy Portfolio by combining both data.
Correlations=0.1*22%+(-0.05)*15%+0*9%+0.1*15%+0.2*5%+0.3*3%+0.2*6%+0.2*7%+0.5*7%+0.1*4%+1*7%+(-0.1)*0%
=0.1835

(c) Because TIPS has a relatively low correlation with other asset classes in Policy Portfolio (Except Domestic bonds, because of