A bond portfolio manager holds three bonds in her portfolio. All the bonds have

Question

A bond portfolio manager holds three bonds in her portfolio. All the bonds have the same duration. Bond 1 has a market value of $25,000,000 and a convexity of 2, Bond 2 has a market value of $13,300,000 and a convexity of 8.5, bond 3 has a market value of $32,343,000 and a convexity of 13. Assume the portfolio manager strongly believes that interest rates will drop over the next six months. Which of the following actions would allow her to benefit most from the projected decrease in rates?

Buy $10,000,000 worth of bond 3 and sell more of bond 1

Buy $10,000,000 worth of bond 2 and sell more of bond 1

Buy $10,000,000 worth of bond 1 and sell more of bond 3

Buy $10,000,000 worth of bond 1 and sell more of bond 2

Explanation / Answer

Option A

As price change is -duation*(change in yield)+convexity*(change in yield)^2

Hence, as duration is same, the maximum convexity would benefit the most due to rate change

So, Buy more bond 3 and sell Bond 1

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.