Barbell are usually riskier than bullet portfolios for 2 reasons:
1.Barbell experiences the lower reinvestment rate longer than the bullet 2.More of the barbell portfolio is still outstanding at the end of the investment horizon.
What does the second point mean? At the end of the investment horizon, I would assume that either the barbell and bullet portfolio would cover the liabilities, regardless of which is riskier.
I’m guessing the only reason you would use a barbell immunization strategy is when the liabilities are also barbell shaped? When else would you use it?
I believe they mean that the long term bonds are still in your books (they become medium term) before you want to remove them off your books. So you have got a duration exposure there. Barbells also have a greater convexity than bullets which helps your assets to meet liabilities when there are interest rate fluctuations although they might yield lesser.
Bit confused by the above poster’s answer. Do you mean they become medium term once the liability is repaid? Additionally, why do barbells have greater convexity than bullets?
I thought the purpose of using the barbell strategy was that it was less exposed to non-parallel shifts in yields. So if yield curve flattens, then you should benefit by owning long bonds and be hurt by owning short term, but your ability to match the liability stays the same.
Thanks @daharmattan1 for explaining it detailedly. @ajb…for example: your barbell has 2y and 10y bonds which can equal a bullet of 5yr ultimately meeting a liability that has a Duration of 5yrs. Remember that a 10y bond becomes a 5y bond in 5 years time. So you’ll still have a 5y bond’s exposure unless you choose to sell it. As part of immunization, your PV’s and Durations match and thus they match your liabilities when due and so curve changes don’t matter in meeting your liabilities. Secondly, Convexity is the weighted average square of time to maturity. So it moves with the square of time. And you’re having both, a short term and long term bond whose maturities are squared is greater than the square of a medium term bond’s maturity. A rudimentary example as a rule of thumb: (2^2 + 10^2)/2 > 5^2