You manage a portfolio of bonds for the Kentucky Teacher Retirement System. The

Question

You manage a portfolio of bonds for the Kentucky Teacher Retirement System.

The weighted-average maturity of all bonds in the portfolio is 18.5 years.

According to the actuaries, you must maintain that average maturity (i.e. you cannot increase or decrease the overall weighted-average maturity of the bonds in the portfolio).

McWeber, Zenger and Gnan is a Regensburg-based economic Think Tank. They have forecasted a sharp rise in the U.S. yield curve. The result would be a significant increase in both short-term and long-term interest rates in this country. Understanding the negative impact that increasing rates have on bond values, you are concerned. What are changes that you can make to the bond portfolio to minimize the effects of the interest rate risks?

Explanation / Answer

I would try to reduce the maturity of the bond as higher the duration higher would be the change in price of the bond as a result of the change in interest rate. Therefore, as a bond portfolio manager, I would sell some of the long term bonds and buy short term bonds in order to reduce the duration and interest rate risk.

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