V4, P39~40 The statements concluded that in case that SHORT RATES “decline” while LONG RATES go up, the BULLET portfolio has less exposure to changes in the interest structure than the BARBELL portfolio because BARBELL portfolio is exposed to higher REINVESTMENT RISK and REINVESTMENT RISK determines IMMUNIZATION RISK ? In above statements, Shall the BARBELL portfolio be exposed to not only the higher REINVESTMENT RISK but also to higher PRICE RISK (capital loss) ? Why only the REINVESTMENT RISK is accounted for in the determination of the IMMUNIZATION RISK ? Why the PRICE RISK is not accounted for ? On the other hand, in case that SHORT RATES “rise” while LONG RATES fall, is it that will BARBELL portfolio outperform the BULLET portfolio because reinvestment rates of BARBELL portfolio will be higher than those of the BULLET portfolio and the increases in the prices of BARBELL will result in capital gain ? In all cases, BARBELL portfolio is riskier than BULLET portfolio ? Any one can clarify / explain clearly ?
In a barbell portfolio, the price increase from the longer duration instruments will produce a gain that more than offsets the loss on the short term instruments. Barbell is riskier since you are exposed to twists in the yield curve in addition to shifts.
bpdulog Wrote: ------------------------------------------------------- > In a barbell portfolio, the price increase from the longer duration instruments will > produce a gain that more than offsets the loss on the short term instruments. Yes, in case that SHORT RATES “rise” while LONG RATES “fall”, and it will outperform a bullet portfolio. So, bullet portfolio is riskier than barbell portfolio in this case, right ? > Barbell is riskier since you are exposed to twists in the yield curve in addition to shifts. Why ? It is not necessaily so, I think.
shorter duration bonds - the cash flows are exposed to the “RISE” rates for a smaller time period. LONG duration bonds - have the longer duration - exposed to the FALL rates for a longer time. So barbell only would be the riskier one. Longer Duration bonds would have the reinvestment rate risk for the longer period of time. In a bullet portfolio - all the entire cash flows are available at a single point in time.
cpk123 Wrote: ------------------------------------------------------- > shorter duration bonds - the cash flows are exposed to the “RISE” rates for a > smaller time period. LONG duration bonds - have the longer duration - exposed > to the FALL rates for a longer time. So barbell only would be the riskier one. > Longer Duration bonds would have the reinvestment rate risk for the longer > period of time. For barbell portfolio, if SHORT RATES “rise” while LONG RATES fall : reinvestment return from short duration bonds will be higher (the cash flows are exposed to the “RISE” of the rates for a smaller time period) and the the price rise for long duration bonds will also be higher (due to the fall of LONG RATES). So, comparing with the bullet portfolio, barbell portfolio is more favorable (less riskier), right ? On the other hand, why only the REINVESTMENT RISK is accounted for in the determination of the IMMUNIZATION RISK ? Why the PRICE RISK is not accounted for ? What’s wrong with me ? Can you or anyone else can clarify ?
If you hold the bond till maturity , price wouldn’t figure into it , assuming there is no default. While reinvestments could add up to differnt amounts depending on how rates change, bond held to maturity will return par.
if both portfolios set the duration out to the horizon length, then both go immune to parallel rate changes. when it’s not parallel, though, just think to yourself the one with the LEAST reinvestment risk has the least immunization risk. the barbell since the maturities are all scattered has more reinvestment risk and is the riskier portfolio. or as janakisri says up there, almost think of the bullet more like a zero coupon- with no default, you get your $$ back at the horizon date, make your return, done and done. if you have stuff maturing earlier than that horizon date and the interest rates start twisting in non-parallel ways, you now are exposed to risk.
janakisri / bannisja, Thank you very much for your responses ! However, I am still confused by following issues. Regarding the immunization risk, is it that the long maturity bonds of a barbell portfolio must be sold out before their maturity dates to meet the requirement of the liabilty ? Let’s take a look at the Exhibit 17 on P39 (V4). In panel (A) with a barbell potfolio, the two bonds are matured at T=1 (short bond) & T=10 (long bond) respectively, and the Horizon Date is at T=5 (the date at which the liability is due). In this case, is it that the long bond with maturity of 10 shall be sold out at T=5 to pay the liabilty ? If it shall be sold out at T=5 under the scenario (as descirbed 3rd paragraph on P39) that SHORT RATES “decline” while LONG RATES “go up”, then the long bond will realize a price fall (capital loss). What I mean here is that the long bond barbell portfolio shall not be hold until its maturity date and it seems that the price risk (capital loss) shall be accounted for too in determining the “immunization risk” while it is said in last paragraph on P39 that “only” reinvestment risk" determines “immunization risk”. Why ?
i could be wrong, but i don’t think of it that at t = 5 you’d be forced to sell the t = 10 bond. it’s more so that you combine a bunch of stuff so that when all of it matures or you hold it in your portfolio, in theory you have the assets that matches the duration of your liability and would have the capacity to pay it off. so the bullet since you get payment right around when the liability is due makes it easy- great- your bonds mature, you pay your liability, easy peasy. if it’s staggered all around and your T = 1 matures, then while in theory if rates stay the same then that combined with your T = 10 jobby makes your t = 5 liability paid, what happens now if interest rates drop and you can’t reinvest your T = 1 cash at the rates you had implied to make this T = 5 work? you have the reinvestment risk then of the shorter term stuff. the t =10 just think it’s going to maturity. so if interest rates never moved or moved parallel, in theory either portfolio would do the job. it’s when you get twists, though, that the stuff that matures early may reinvest at worse off rates than you had assumed which then in light of the full portfolio to pay the liability may fall short. i think you’re overthinking it a bit. keep it simple enough- you definitely understand the concept of it all.
bannisja, I don’t understand what are said by you well. Your conclusion is that price risk (capital loss) shall not be accounted for in determining the “immunization risk” ?