Hello there!
I’m currently reviewing yield curve strategies and there is something that I don’t really grasp
Let’s say I expect the yield curve to steepen. As I understand from the curriculum, the bullet portfolio would be the preferred solution. But why couldn’t I opt for a barbell portfolio, shorting the long end and going long the short end, thus gaining a better performance than the bullet?
Thanks!
I think because the long end have much higher duration than the short end (very low duration), so when we expect the curve is steepening (short rates fall and long rates rises) => the price decrease in the long end is much larger than the price increase in the short end.
This is true, without any doubt and this is the reason why you should prefer a bullet portfolio
But if I anticipate such a steepening, I think there is nothing wrong in shorting the long end which, as you say, has a much higher duration (and thus, with a short position, a greater gain)
In this context, a barbell portfolio is long the short end and long the long end.
I believe that you’ll find that if you get a question such as this on the exam, they’ll stipulate that the portfolios (barbell, bullet, ladder) have the effective (or modified) duration as each other.