Scenario 1: instantaneous upward parallel shift of 100 basis points.
Under Scenario 1, which of the following portfolio construction strategies is most
appropriate?
A. Selling convexity
B. Choosing a bullet portfolio
C. Choosing a barbell portfolio, with the bonds with durations of 1 year and 8 years
Answer is C. This I don’t believe is correct. You want to choose a portfolio with the lowest convexity when IR are going up. You don’t want to choose the portfolio with the highest convexity. Somebody please help me make sense of this- is there a mistake in the mocks?
"The first portfolio concentrated in a single intermediate maturity is often referred
to as a bullet portfolio. The second portfolio, with similar duration but combining
short- and long-term maturities, is a barbell portfolio. Although the bullet and barbell
have the same duration, the barbell’s higher convexity (40.229 versus 26.5 for the bullet) results in a larger gain as yields-to-maturity fall and a smaller loss when yields-to-maturity rise. Convexity is therefore valuable when interest rate volatility is expected to rise."