for cash instruments.
“if for example, a manager thinks that interest rates are set to rise, he will shift from the 9-month cash instruments down to 3-month cash instruments”
whats the reasoning behind this?
does the interest rates as indicated in the quotes refer to short term rates and hence the shift to shorter term cash instruments?
thanks!
no one/???
I would assume reinvestment risk…If rates are expected to rise the yield curve would be steep…why lock in a rate now for 9mths, when you can lock in a 3 mth rate and hopefully lock in a higher rate for 6mths at a higher rate.
This is all down to perception of rates at the time and going forward of course.
I’m assuming you quoted this out of the Capital Market Expectation reading context.
In Example 31, p87: In a rising interest rate environment (expectation of future increases), keeping maturities short is a good strategy by rolling over. The rationale is that you expected to earn a higher yield a few month from now than committing to a lower yield of longer maturity now. It works best when the rate increase is higher/faster than expected.
For a declining int rate environment, longer maturity is to lock in the higher yield now.
I am assuming the “cash intruments” pay a fixed rate. If interest rates rise, the value of fixed rate instruments will decrease. (Always remember: rates rise = value of bonds decrease, and vice versa).
Longer maturity instruments have longer duration, i.e. their prices are more sensitive to changes in interest rates. So, if you think rates will rise, you should switch to instruments with shorter duration.
when interest rates rise, we reduce duration…go to short end of the curve
interest rates fall, other way around
Modified/effective duration.
Yes (and long-term interest rates, too).
Yes.