Ch.10 · Benchmarks and Performance Evaluation · hard
What is 'price discovery' and why is it challenging for illiquid bonds in debt fund portfolios?
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EXPLANATION
Price discovery for liquid bonds occurs continuously through active trading on exchanges. For illiquid bonds (low-rated, small issuers), there are few or no trades, making fair value estimation difficult. AMCs must use matrix-based pricing or valuation agency estimates for such bonds. Poor price discovery can lead to NAV misstatements and sudden large corrections when a credit event occurs.
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