Broad’s first meeting of the day is with Gabriella Bhavathi. Bhavathi is an active manager with a view that the yield curve is expected to undergo a bear flattening. She has positioned her portfolio to profit from this view using only zero-coupon bonds with maturities of two and ten years. Broad points out that the view of the chief economist at Equinox is that the yield curve will flatten but not undergo a bear flattening. Broad suggests that Bhavathi bring her portfolio into line with the view of the chief economist unless she has good reason not to do so.
If Bhavathi brings her portfolio into line with the view of Equinox’s chief economist, Bhavathi will most likely adjust her portfolio position by:
A) reducing an existing short position in the 2-year zero-coupon bond.
B) increasing an existing long position in the 2-year zero-coupon bond.
C) increasing an existing short position in the 10-year zero-coupon bond.
I would have went for C. My explanation: you do not position for a bear flattening curve, but simply flattening, so you want to go into longer durations…
Correct answer is A. Could someone please explain why? Thanks!