Anyone can explain what implementing a trade that steepens the yield curve means? It was in a portfolio topic test and I’ve never heard of that before. Thanks!
I believe you meant “riding the yield curve” strategy? It’s under Reading 35: The Term Structure
Rising the yield curve strategy basically means that you buy bonds which are longer than your investment horizon.
For example, you’re a trader at a bank and your boss has requested you to invest in 1Y bonds because there are 1Y liabilities to be met. But you’re a smart trader, and in an effort to make more money, you decided to instead buy 5Y bonds, which are longer than your investment horizon. You hope that as the 5Y bonds mature and “ride/roll down the curve”, your bond will be valued at successively lower interest rates and higher prices.
But this trade will only work out if (i) your yield curve is upward sloping (allowing you to roll down), and (ii) your yield curve doesn’t change much so that realised rates in the future (e.g. 4Y, 3Y) will be lower than current forward rates (if not, you can just invest in the forward rates and make the same return. Please refer to the link below for a better example and explanation)
Here’s a great example and explanation provided in a previous analystforum post
https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91353588
Hope this helps
Riding the yield curve may not be the same as steepening the yield curve, as I understand it. The example given in the TT was that during a recession, central banks cut the policy rate which decreases ST rates more than LT rates. I can’t remember what trade you would implement here so I’ll have to let someone else step in. My guess would be that you would want to buy a shorter term bond before the steepening effect in order to benefit from the decline in rates.