LOS 24 - Yield Curve Strat - Practice Pb 15 - Ride the curve VS Buy and Hold strategy

CFA Level III
#1

Hi all

so here is the question as per the book:

Exhibit 1. Cefrino Sovereign Bond Fund Current Fund Holdings of On-the-Run Bonds

Maturity** Coupon/YTM Market Value Modified Duration** 1-year 0.78% $10,000,000 0.99 3-year 1.40% $10,000,000 2.92 5-year 1.80% $10,000,000 4.74 10-year 2.34% $10,000,000 8.82 30-year 2.95% $10,000,000 19.69 Portfolio 1.85% $50,000,000 7.43

Based on Exhibit 1 and Abram’s expectation ( Abram expects a stable yield curve) for the yield curve over the next 12 months, the strategy most likely to improve the Fund’s return relative to the benchmark is to:

  1. buy and hold.
  2. increase convexity.
  3. ride the yield curve.

For me, both A and C are valid answer. the decision will be made on the transaction costs, the holding period etc…

For the book, the answer is C.

Can someone tell me why C is better than A? a ride the Yield Curve is always better than a buy and hold for stable curves?

thanks

#2

Rates stable = ie interpolated 2 year say is 1.09% now; it is going to be the case 1 year from now

The 3 year is currently at 1.4%, in 1 year it is going to be “still” be at 1.4% (theoretically 2 year); however, the 2 year is 1.09. The spread of 40 bps.

If you buy and hold, you lose the reinvestment returns on the 40 bps worth. Only “roll the curve” will allow you “improve” the funds return

hth