Duration - quick question

“To reduce duration, you would take a position that is positively correlated with interest rates” Read this in a practice question, and I do not understand the logic behind this - can you please explain why?

Floating rate bonds are positively correlated with interest rates, whereas fixed rate bonds are negatively correlated with interest rates. Think about it that way.

If you are long a bond, as interest rates increase, the value of your bond decreases. Imagine you have a 30 year zero in your portfolio and nothing else, so the duration of your portfolio is 30. so if you want to reduce the duration of the portfolio, you add a new position that is positively correlated with interest rates - something that INCREASES in value as rates increase to offset the loss on your long bond. This will reduce the overall portfolio duration, or sensitivity to interest rates.

When IR increases, you want to receive float and pay fixed. This will have a negative net duration and thus reduce the overall duration. :expressionless:

think the statement is wrong. should instead read “To reduce duration, you would take a position that is NEGAtively correlated with interest rates” to reduce duration of a bond portfolio (in anticipation of rates rising), we should sell bond futures (say for eg) and futures price is inversely related to changes in intrest rates (if rates rise, futures decline in value) i.e. futures price and intrest rates are negatively correlated.

what’s wrong today??? i am getting every Q on the wrong foot. too bad for me :frowning:

level3aspirant - the statement i wrote is definitely correct - i checked with a CFA tutor just didnt get his detailed explanation. I think Skillionaire and LaGrandeFinale give a pretty good explanation Thanks

yup … sorry for any confusion.

just wondering what’s wrong with my logic above? i still feel it seems to be correct though if i consider managing duration with futures (instead of swap)… help anyone. >> to reduce duration of a bond portfolio (in anticipation of rates rising), we should sell bond futures (say for eg) and futures price is inversely related to changes in intrest rates (if rates rise, futures decline in value) i.e. futures price and intrest rates are negatively correlated. >> TKVM

level3aspirant Wrote: ------------------------------------------------------- > just wondering what’s wrong with my logic above? i > still feel it seems to be correct though if i > consider managing duration with futures (instead > of swap)… help anyone. > > >> to reduce duration of a bond portfolio (in > anticipation of rates rising), we should sell bond > futures (say for eg) and futures price is > inversely related to changes in intrest rates (if > rates rise, futures decline in value) i.e. futures > price and intrest rates are negatively correlated. > >> > > TKVM Because you shorted the futures, so your position is the opposite of negatively correlated. That’s positively correlated - rates go up, the value of your SHORT position in futures goes up as well.

level3 - it’s because the position you’re describing is a short futures (sell futures) position. So yes, you could reduce duration by either: 1) shorting an asset that is negatively correlated with rates, or 2) going long an asset that is positively correlated with rates.

thanks skillionaire and janky … mind at rest finally.

level3aspirant Wrote: ------------------------------------------------------- > just wondering what’s wrong with my logic above? i > still feel it seems to be correct though if i > consider managing duration with futures (instead > of swap)… help anyone. > > >> to reduce duration of a bond portfolio (in > anticipation of rates rising), we should sell bond > futures (say for eg) and futures price is > inversely related to changes in intrest rates (if > rates rise, futures decline in value) i.e. futures > price and intrest rates are negatively correlated. > >> > level3aspirant You are right. I think the original statement is a bit confusing, leading one to interpret it in different way. The most correct statement is To reduce duration, you would take an SAME SIDE position of another instrument that is POSITIVELY correlated with interest rates or To reduce duration, you would take an OPPOSITE SIDE position of another instrument that is NEGATIVELY correlated with interest rates so if want to reduce duration of a bond portfolio you OWN, either - sell (opposite side) futures (negative related with IR) - own/buy (same side) pay fix swap (positive related with IR) Same logic if you have LIABILITIES (i.e., short a bond portfolio)