Hey I did this mock the other day. and in the question they had a negative butterfly twist, let’s nust say 30 yr, 10 yr, and 5 yr rates where involved.
and just for example sake, let’s say the 30 year fell 25 bps, 10 year moved 25, and 5 year moved 25.
it asked us which portfolio would outperform and gave us three options:
The butterfly that is long in the wings and short in the body
Butterfly is short in the wings long in the body
A barbell
so - I automatically ruled out portfolio 2 - and struggled with choosing between 1 & 3. I chose the barbell but it was actually the portfolio that is long in the wings & short body.
Someone mind breaking this down for me where I went wrong? My intuition had me believing that the duration effect of the 30 year bond would have FAAAAR outperformed the duration effect of a portfolio that had LESS (this may be where I’m wrong) invested in 30 year bonds.
The duration effect of a 30 hear bond is going to be like 16 times MORE powerful than the duration effect of the portfolio that had a short body, so, I sad it was the barbell, but it was the butterfly that’s long wings short body.
Is it because in a barbel you don’t necessarily have to go short the intermediate years, while the butterfly does, which gives you better overall performance by taking advantage of change in intermediate years?
while you’re exactly right - it really depends on the portion of the portfolio that would be invested in each different leg. If I had a barbell that was 70% invested in the 30 year and 30% invested in the 5 year, my duration would effectively (no pun intended) be higher than a butterfly that was 33% invested in the 5 year, 33% invested in the 10, and 33% invested in the 30… no???
i hope they hire me to write exam questions someday. I will screw with the candidates minds so hard.
Am I over complicating the crap out of this? Should I just go outside and enjoy a Friday night for once in my life? No joke, I’m actually typing this on my iPhone at the local quaint neighborhood bar doing my flash cards and drinking a milk stout.
I’d like to point out that the ultimate level of all the yields for those bonds will determine if the barbell has a higher duration or not against the butterfly - please I’m not an idiot.
This is a super barbell strategy. You make more returns tha barbell here by going short intermediate term bonds and using the proceeds to buy short and longer term bonds as opposed to a pure barbell strategy where you’d only be buying long and short term bonds.