I am having some difficulty in understanding Q3. For example, for the US bonds, I understand why Buying 5s and selling 30s makes sense (highest return) and why buying 10s/selling 30s makes sense too )offers the biggest increase per unit of duration (0.4037%)). I understand that the goal is to offset the change in duration, however, I’m not understanding how the offsetting positions are chosen in this example. Any help would be appreciated!
Hi jdee,
you need to keep in mind three criteria when choosing the opposite trade:
Choose a trade with opposite duration (to be duration neutral)
Choose a trade that is not involving the same maturities as the initial trade (in this case, if the initial trade is long 10s/short 30s you cannot have an opposite trade involving either 10s or 30s as you have already invest your capita in 10s and 30s in the first trade)
From the trades remaining from point 2, find the ones that increase (or if negative, decrease less) your return per duration unit.