Capital Mkt Expectations & Yield curve in Fixed Income

CFA Level III Economics
#1

I have following two doubts

  1. In Capital Market expectation (Reading 18, vol 3)- Question 6th of EOC practices:

It gives a series of 1 mth rate & 6 mth rates & spraed between the two:

Question B is asking whetehr it is good to invest in 1 mth rate & keep on rolling for 12 mths or invest in 6 monthly rates

Answer to this is saying that since the rates are falling that is yield curve is inverted it is good to increase duartion hence to invest in 6 moth rates.

I tried solving it in excel & comparing the two options but I am getting end value greater in one month rolling option…any clues on this ???

  1. On conceputual level Capital mkt expectation (Reading 18) & Fixed Income (Relative Value for bonds) eplain that

When yield curve is upward sloping- Decrease duration & downward slopping or flattening - Increase duration.

  • this is in essence to take make portfolio less sensitive to negative moves & more sensitive to positive moves.

  • But in Derivative based enhanced indexing (Equity Portfolio Mgt) Reading 27, says that

When yield curve is upward sloping - Incease duration i.e. invest in Long duration bonds & vice versa…

I am confused on these twe opposing views. One is taking about yield earning aspect & other is taking about price aspects??? ----could any one help to put me this is perspective.

Thanks in advance.

#2

If inverted I will choose short term cause rates are higher,when curve flattens no reward to buy long term so go with short term

#3

raj123 i have the same conclusion as yours. were you able to solve the problem?

#4

You’re assuming that the yield curve will remain unchanged. Why?

It depends on your explanation for the shape of the yield curve.

Pure expectations: future rates will be the forward rates implied today.

Preferred habitat theory: yield curve shape may remain unchanged.