How would your portfolio of bonds react to a flattening of the yield curve? To me, the steepness sensitivity on the long end should be negative, in the sense that if the yield-curve flattens due to long-term rates falling, you “gain”. I got a question wrong based on this concept. Anyone can help out?
Yes, if long-term rates fall your long-term bonds increase in value. If the curve flattens due to short-term rates rising, your short-term bonds lose value. If the flattening is due to a combination of these two effects, the net effect on your portfolio depends on the exact makeup of your portfolio.
What exactly did you get wrong?
are we talking about callable bonds? Please elaborate more about the problem.
Generally Call option value increases when yield-curve flattens. Since Call go in the money. Opposite is true for puttable bonds.
We are talking about a portfolio of straight bonds. I am afraid i cannot give you more details since it’s part of the topical assessments (1st one of fixed income) off the CFAI website. I cannot post the question here.