Riding the yield curve - Mock Akron

“First, it increases the yield of the portfolio by buying bonds with maturities longer than their investment horizon whenever the yield curve is upward sloping, is expected to maintain the same level and shape and spot rates rise as predicted by forward rates.”

I thought spot rates should not rise as predicted by forward rates to ride down the yield curve?

Yes you are right

Your returns are higher if spot rates are below than what’s predicted by forward rates

Is there a second part to it?

Think about it in terms of duration, if you have a 5 year investment horizon, and you expect rates to fall but curve to remain upward sloping, would you invest in a long or short dated bond? You would invest in longer duration because the increase in value due to valuing cashflows at a proportionally lower discount rate would be larger.

FYI - ‘Riding the Yield Curve’ is the SAME as ‘rolling down the yield curve’ …

Well I still do not get it: Let’s put it this way, how can the yield curve maintain the same level and shape and on the other hand spot rates rise as predicted by forward rates. If spot rates evolve as predicted, should this not change level and shape of the yield curve?

I understand the second part to mean that if spot1 = 2, f(1,1) = 3, f(2,1) = 4, then next year spot1 = 3 and f(1,1) = 4 (implying changes of the yield curve)?

In order to make sure that I got it right. The riding the yield curve will be only beneficial when spot rates increase with a lower level than their future rates. As this will allow the holder of the long maturity bond to short it at a higher price than the one he purchased it with and from the new buyer’s side, he will benefit from the higher yield he will receive compared to the existing yield generated by the low spot rates.

Did I get it correctly!

Now you did.

Thanks :smiley: