fixed income markets. In many ways, the fixed income markets are more complex than the equity markets as there are many dimensions to consider when constructing a fixed income portfolio. There are so many questions to ask yourself, whether you are investing in a fixed income portfolio or you are an active fixed income portfolio manager. Should I own short maturities or long maturities? Should I own government bonds or corporate bonds or some combination? If I invest in mortgage-backed securities (MBSs), am I taking on some unintended risk? Should I invest internationally? If so, should I hedge the currency exposure? These questions and more will not be answered for you in this chapter. What we will try to do is to give the reader a sense of what questions should be asked when thinking about the fixed income component of an overall portfolio. First, we will discuss the various risks that bond portfolios may be exposed to in order to understand what drives fixed income returns and volatility. Next, we will examine the fixed income benchmarks that are used by many market participants to define the desired neutral exposures to each of the major fixed income risks. Then we will identify the main strategies that active fixed income managers use to achieve higher returns than a passive indexed portfolio. And last, we will describe and then demonstrate the process that we in Goldman Sachs Asset Management fGSAM) use to determine an optimal allocation of these active strategies to maximize the information ratio, given a client's investment objectives and constraints. SOURCES OF FIXED INCOME RISK Before we begin the discussion of the various risks taken in fixed income portfolios it is necessary to understand what risk means in a fixed income context. After all, fixed income instruments have fixed cash flows and therefore no risk. Right? Also, many have said that it doesn't matter if the price of a bond goes down because you can always just hold it to maturity and therefore the price volatility of a bond is not important. While it is true that due to the nature of fixed income securities they are