questions on bond indexing

Here is a few questions I am not sure about the answers.

1, What are the primary factors? Duration is one primary factor, what else? Are primary risk factors and major risk factors the same thing?

2, “Small” in small risk factor mismatches does not refer to small risk or small risk factor. It’s MINOR MISMATCH of primary risk factors, correct?

Primary Risk Factors =

  • Duration, PV Distribution of Cash Flows, Key Rate Duration.
  • Credit Sector Spreads, Yield Curve Twists, Term Structure

Small refers to the size of the mismatch there.


1, Is Term Structure a risk factor or risk measure here? I saw it in the book. Not quite sure what it refers to.

2, Any level of Duration Mismatch is not Small Risk Factor Mismatches?

For both Primary Risk Factor Matching (Method 2) and the Small Factor Risk Mismatches (Method 3) - Duration is always matched. The active manager has permission to change other factors around to a little extent in the Method 3 (Small factor mismatches). Hence his tracking error will be higher with this method.

Term Structure would be a risk Factor. not sure how it becomes a risk measure… How are you going to measure it? It is a risk factor because it can be seen (should say expected/unexpected changes in term structure cause yield / spot rates change and causes the twists of yield curve).