Clarkson believes that the Fed will be raising interest rates regularly over the next two years in an attempt to slow an overheating economy. She is considering how the bank could take advantage of that scenario: a) Barbell approach and under-weight investments in short-term securities b) Bullet strategy and over-weight investments in short-term securities c) Ladder approach and over-weight investments in short-term securities Answer is b. Why would we over-weight investments in short-term securities? If the fed raises rates, short-term securities are hurt the most.
Eh? When rates are increasing, you want to lower portfolio duration.
Detailed answer: The ladder strategy approach staggers investments with equal amounts invested throughout the maturity spectrum. This approach averages exposure to interest rates and does not necessarily require an aggressive bet on interest rate direction. Over time, periodic reinvestment of maturing securities is required. With a barbell approach, investments are made both on the short and long ends of the maturity spectrum; weighted more heavily on one end or the other depending upon the manager’s interest rate outlook. When rates are expected to rise (as Clarkson anticipates), short-term securities can be over-weighted using a bullet strategy which concentrates securities in one area on the yield curve. (Study Session 9, LOS 28.k) This question tested from Session 5, Reading 20, LOS i. I still don’t get it.
AndyPettitteIsGreat Wrote: ------------------------------------------------------- > Detailed answer: > > The ladder strategy approach staggers investments > with equal amounts invested throughout the > maturity spectrum. This approach averages exposure > to interest rates and does not necessarily require > an aggressive bet on interest rate direction. Over > time, periodic reinvestment of maturing securities > is required. With a barbell approach, investments > are made both on the short and long ends of the > maturity spectrum; weighted more heavily on one > end or the other depending upon the manager’s > interest rate outlook. When rates are expected to > rise (as Clarkson anticipates), short-term > securities can be over-weighted using a bullet > strategy which concentrates securities in one area > on the yield curve. (Study Session 9, LOS 28.k) > > This question tested from Session 5, Reading 20, > LOS i. > > I still don’t get it. I don’t know how else to explain it. If you are certain interest rates are going to increase, you want to shorten portfolio duration as much as possible to reduce market impact. Now, if you are an endowment with a long time horizon you really don’t care because you don’t have to meet liabilities an want stable long term cash flow which would probably mean you hold long term bonds to maturity.
I just have it as a simple concept in my mind Increasing Interest rates = Decrease Duration = Underweight Long Term bonds (Higher duration) and Overweight Short Term bonds (Lower Duration) So, Lower Duration - Higher Duration (you are short LT bonds) = decrease duration and vice versa… Hope this helps…
It will hurt either way, short or long duration, but with shorter duration you get your money back sooner and re-invest at higher rates.
Agrred…It’s tradeoff between price risk and reinvestment risk.
I guess I should be assuming that I’m over-weight short term securities *relative to long-term securities* My answer was assuming I’d sell all short-term securities and go to equities.
You would move in equities when they are tightening the economy to slow down growth?
Andy Petite is smoking some of that good stuff
Yes, interest rate is going up. Duration need to shortern. So overweight short term bonds.
bell99 Wrote: ------------------------------------------------------- > Yes, interest rate is going up. Duration need to > shortern. So overweight short term bonds. @Yodhava When interest rates are rising, why would you want to hold bonds? The only reason to hold bonds whatsoever is because you are stuck with a benchmark, hence you will add value be underweighting long term bonds and increasing short term bonds and going max on treasury bills(or cash). If there is no benchmark at all, it is better to hold 100% cash and you will not be hurt if interest rates really go up as forecasted. You will invest your cash at high yields and everyone is happy.
If there are no constrains, I would leverage up and borrow to the maximum to buy an interest rate puts in a rising interest environment… haha
…using swap – CFAI’s favorite.