Barbell vs. bullet portfolio

I have a fixed income question: When short term rate rise and long term rate fall. Which portfolio will outperform? Why? Any one can shed some light on it? thanks!

barbell. Gain in LT leg of barbell will exceed loss in ST leg. This has been discussed here recently. - sticky

not sure about that assessment… question is way too vague…but here’s my 0.02$ say you have a bullet portfolio with a big duration/PVBP around the 5yr point, and a barbell portfolio where rate sensitivity is similar along all points of the curve, now if u assume total duration/PVBP is the same for both portfolios… if the 6m and 5 yr rate were to move 50bps (rise for the short term rate and fall for the long term) the bullet portfolio would outperform the barbell 2 things u have to keep in mind about fixed income products…although it cant wait til after the exam… 1- assumption of parallel move in rates => it never happens in real life…to this day i still dont know why it is the standard hypothesis used by academia 2- again, wait until after the exam to think about that, but in real life, u’ll see that in most bond portfolios, the most important factor is ur exposure to every single point of the curve…thats what u base ur decisions on… anywayz, good luck to all Kratos, CFA

sticky Wrote: ------------------------------------------------------- > barbell. Gain in LT leg of barbell will exceed > loss in ST leg. This has been discussed here > recently. > > - sticky For CFA purposes, that (alone) is the right answer. LT bonds have > Duration than ST. That’s why their price increase outweighs the st bonds’ decrease.

Bullet outperforms, long end drop, bullet benefit. In the case of a barbell you have the shortend underperforming and the long end outperforming.

The questions I’ve encountered on this subject pertain to zero coupon bonds. A portfolio split between 1 year and 10 year bonds will outperform , say, a 3 year bullet portfolio.

haha this question is from Sample Exam #1…You want the Short Term Bullet b/c ST rates are expected to decrease adn LT rates are going to Increase…if you had a barbell the 1/2 of your portfolio in ST would gain but the other half of the barbell in LT rates would lose value… So you are better off with a Bullett in ST .

I don’t understand this fascination with barbell… it all depends on the maturity of the bullet!

No sh!t, that’s why I said a ST (Short Term) bullet. b/c it will benefit more from a ST Rate decrease b/c its on the ST end of the Yield curve while the Barbell has maybe only 50% in the ST end of the YC…

CFAAtlanta Wrote: ------------------------------------------------------- > I don’t understand this fascination with > barbell… it all depends on the maturity of the > bullet! If you have a bullet portfolio you will be primarily exposed to long term rates. Barbell is more to do with diversifying risk and protecting against yield curve changes. For instance 2 and 10 years are often quoted maturities for yield curve risk as many issues are issued between those times and there are a preponderance of bonds there (for the US yield curve it’s mainly 2-10-30 as being a good proxy for non-short term rates and maybe throw in a 5 for good measure). So you will match the yield curve better by barbelling it and protect against twists better.

I go with ST Bullet. Can’t see how barbell would outperform the bullet in that scenario. Also, I read somewhere in one of the Schweser Practice questions that in a Barbell strategy, an investory normally overweights either the short-end or long-end of the yield curve rather investing equal amounts on either end of the extreme - thought it didn’t sound right???

Ok, so we would want a “Long” duration bullet (portfolio) strategy if the liabilities were long term as well. Alternatively, we would look to a barbell structure (portfolio) if a long term bullet was not available to over our Long term liabilities. correct?

Sorry, meant to say; Alternatively, we would look to a barbell structure (portfolio) if a long term bullet was not available to “Cover” our Long term liabilities.

If both portfolios -barbell and bullet - have durations= horizon date–>bothe are immune to PARALLEL rate changes But when there is NON-PARALLEL change in interest rate --> barbell portfolio is riskier

barbell might outperform when you expect twist in interest rates. if you have exactly similar duration of portfolio - a parallel shift doesnt matter. if you have a slightly off duration pick the portfolio with shorter duration for expected upward move in rates, longer duration for downward rates move. in the example you give: When short term rate rise and long term rate fall. LONG TERM RATES FALL - the duration impact is much greater on portfolio from long term bonds (think of dollar value of the basis point change - you can do the calculation once to understand the logics). so you would prefer to have exposure to as long duration as possible . bullet would normally be somewhere in the belly - 10 years. in that case you would prefer barbell that has a decent size of 30yr exposure. so even both portfolios have same “total” duration your 30year bonds would give a $ kick for every point move greater than that of 10 year. at the same time, the loss on short bonds in barbell will be so minimal for the basis point change. (i do think that doing a math once - takes you 5 sec… use the suggested moves in yields and for simplicity assume zero coupon bonds (same duration as maturitiy) take 2 and 30yrs for barbell take 10 years for bullet… take a look at the dollar change :))

I’m not clear here? what is a short term bullet? given a barbell and a bullet portfolio, you still have to focus on the the same horizon date, right? assume da=duraion assets and dl=duration liabilites… and our horzon date is 6 (dl=6) and our portfolios are; barbell da=2…dl=6…da=10 and a bullet da=5…dl=6…da=7 both have a the same horzon date (duration liabilities = 6) so how is this a short term bullet?

A ST bullet is a Bond with a Short time horizon say 2 years or less.

Thanks Bigwilly so you would use a short term (duration) bullet portfolio in my scenario…if say the horizon date was Dl=2 instead of Dl=6? is that right?