p. 121 of Schweser #3 “A barbell strategy exploits a flattening of the yield curve but can immunize the duration of a portfolio just as a bullet bond portfolio does.” Could sb explain this? - sticky
The second part of the sentence is straightfoward: as long as the barbell portfolio has a duration equal to the horizon length, it is immune to parallel rate changes. The first part of the sentence must have to do with the structure of a barbell portfolio’s cash flows, i.e., the fact that they are dispersed between now and the horizon date. But someone else might have to help for the connecting piece…
from the discussion p 35, Schweser V3: To reduce risk associated with uncertain reivestment rates, the manager should minimize the distribution of the maturities of the bonds in the portfolio around the liability date. … The discussion goes on and they argue that barbell strategy will have more reinvestment risk than bullet strategy, thus bullet is better for immunization of liability. The above, however, contradicts what Sticky quoted from Schweser V3, p121. Can anyone explain?
barbell portfolio is a a portfolio that invests in credit securities of both very long and very short-term maturities. the portfolio can be formed with duration equal to that of overall liabilities to immuinze interest risk (i.e. parallel shift of yield curve) of the liabilities. barbells will do better in a situation when you expect monetary policy tightening and short rates to increase more than long rates, i.e. flatening of yield curve. the short end of the portfolio caputures higher reinvestment rates while the long end doesn’t change much. a bullet portfolio, on the other hand, concentrates on intermediate terms (10 years). it cann’t adjust itself as quickly as barbells do with rising rate occurring only at short end of the yield curve.
in term of share immunization, bullet is no doubt better than barbell simply because it tries to match liability in both the first and the second moment (duration and convexity), while barbell cares only the first moment, duration. but, if a manager believes he has skills in forecasting short term economical trend and yield curve movements, he may like to take the 2nd moment into his own hands to take advantage of his forecast power. barbell gives him that flexibility (or risk exposure) to do that. make sense?
I still don’t understand this. Please refer to the case on p.119. First of all, is the question about single or multiple liability immunization? In the question, “Benson states that a barbell strategy exploits a flatttening of the yield curve but can immunize a portfolio against interest rate risk in a manner similar to a bullet bond portfolio.” … and then Schweser says this is correct. help, help, help! - sticky
I am not comfortable with the word ‘exploit’ in the answer. But immunization risk is really about the reinvestment risk. So, if the curve is flattening then a barbell portfolio will have less reinvetment risk, similar to a bullet, which has cash flows close to the liability.
I think the basic idea is that if you tune the barbel duration to match liabilities, you are protected from parallel yield curve shifts, but you can still make a profit if the yield curve moves from normal to flatter (or possibly even to inverted). The profit comes from the fact that the long term bonds rise substantially more in value than anything else when rates at the long end of the yeild curve fall. Of course, it’s the opposite if the curve steepens.
It’s nice if interest rate movements result in some profit, but I thought that the objective of an immunization strategy is really to lock in the rate of return to meet the liabilities.
bchadwick Wrote: ------------------------------------------------------- > I think the basic idea is that if you tune the > barbel duration to match liabilities, you are > protected from parallel yield curve shifts, but > you can still make a profit if the yield curve > moves from normal to flatter (or possibly even to > inverted). The profit comes from the fact that > the long term bonds rise substantially more in > value than anything else when rates at the long > end of the yeild curve fall. > > Of course, it’s the opposite if the curve > steepens. It’s sort of the opposite but the barbell portfolio has more convexity and is thus a more expensive trade. If someone told me they were immunizing a bullet risk with a barbell portfolio, I would say they were making a curve bet which would probaby not be their job.
i think the best way to understand this is to draw out a yield curve ( flat , inverted and steep ) …barbell startegy would have maturities on both ends of the spectrum ( just like an actual barbell with weights on either end ) you can include short term maturites and long term maturities to match the liability portfolio . You are exploiting the flattening by having maturites @ both ends where as in a bullet strategy you would normally have maturities around a specific time ( i.e right before you have large liability payouts ) Hope this helps …that is how I understand it hopefully I’m correct . | | | | D------------------------D | | |______________________
abacus Wrote: ------------------------------------------------------- > I am not comfortable with the word ‘exploit’ in > the answer. But immunization risk is really about > the reinvestment risk. So, if the curve is > flattening then a barbell portfolio will have less > reinvetment risk, similar to a bullet, which has > cash flows close to the liability. Why is barbell having less reinvestment risk? I thought Schweser says “barbell has more reinvestment risk than bullet” (1st blue box, p.35, Book 3) Even if this is correct or not, how does this relate to my original question? Rudeboi, I understand what a barbell is but how does that relate to my original question? This is getting confusing to me … - sticky
I think you are making this too complicated. Schweser has this little point that you can duration immunize a liability of x with any portfolio with duration x. In this case, they are being clever and pointing out that a barbell portfolio will do better than a bullet portfolio if the yield curve flattens. It will also do better than a bullet portfolio in lots of other interest rate scenarios as it has more convexity. But when you get some increase and steepening in interest rates that makes your barbell diverge from your liability, you can tell your boss that this was Schweser’s “exploiting” immunization and you’re really sorry that your exploiting drove the company into the ground.