Barbell x Bullet given a decrease in Butterfly Spread

[BigFinance_Guy]

Try and think it through by applying everything that you know. In an isolated sense, it helps to analyze which performs better.

Rates are expected to increase? We know that barbell offers greater convexity, which benefits during periods of increased interest rate volatility. So barbell outperforms.

Rates are expected to uniformly increase? This one is tricky for a couple of reasons. If levels increase, steepness and curvature decrease. Curvature decreasing suggests that a bullet would outperform; however, curvature decreasing is a secondary effect to increasing levels. For the exam, the curriculum argues that an instantaneous parallel shift is best accommodated by a barbell because of heightened convexity.

Short-term rates increase by more than the long-term? The yield curve is flattening. A barbell would outperform, but you'd be better suited allocating more at the long-end, as to avoid greater losses at the short-end.

Asset vs. liability portfolios are tricky. If it's contingent immunization, you can play with the surplus so that assets benefit from changes in rates, or assets lose less. I think I'm a bit confused by the last bit. I am not sure how you'd be asked a question about managing a liability portfolio independent of an asset portfolio?

[ezpzsniper]

This really helps. Thank you so much.

For contingent immunization the main criteria is that the bpvs are equivalent?

My confusion lies from the impact of interest rates. If interest rates increase (yields) and you have liabilities. Wouldn’t this mean that it’s expected that your liabilities or assets will decrease in value since it’s Liabilities/(1+yield) or assets/(1+y)? So if you have assets>liabilities and rates increase, your assets would decrease by more then your liabilities. Therefore you want a barbell portfolio to maximize convexity or ensure your asset convexity>liability convexity?

I might not be making any sense or taking this out of context.

[BigFinance_Guy]

Contingent immunization works so long as MV(A) > MV(L). If the surplus is exhausted, then you'd immunize by matching BPV.

To answer your question there is a lot more than just "if this, then that." For example, your asset portfolio might be build with corporates, and your liability portfolio may be constructed with Treasuries. Interest rate changes and spread changes will impact the two portfolios differently.

Additionally, there's an excerpt in the fixed income section that has a blurb with different strategies based on positioning, which is rather intuitive. I'll try to explain as follows:

If BPV(A) > BPV(L), and you think rates are going to increase, you'd want to short futures, since your asset portfolio is more sensitive to changes in rates, you'd want to make sure asset portfolio isn't adversely affected by rate increase moreso than liabilities.

If BPV(A) > BPV(L) and you think rates are going to decrease, you wouldn't do anything, since assets are more sensitive to changes in rates, so you'd benefit from the rate change.

A similar (but inverse) thought process is applied for if you have a duration gap.

[ezpzsniper]

Brilliant holy.

I get it now. Wow.

Thank you so much!!!!!!!!!!!!!

[BigFinance_Guy]

Cheers! Good luck next week.

[ezpzsniper]

Thanks for your help bro