Portfolio Duration Strategy

CFA Level II Derivatives
#1

Orr explains that the 10% total return for the Treasury portfolio since its inception is largely the result of an interest rate decline. Orr believes that interest rates will continue to decline over the coming year, and he suggests that the duration of the US Treasury portfolio increase from three years to four years.

To implement BCA’s duration strategy, the Smiths will most likely:

  1. receive a fixed rate in an interest rate swap.
  2. pay a floating rate in an equity swap.
  3. sell a US Treasury futures contract.

Can someone explain why the first answer is the solution, and how the other strategies would impact the duration of the portfolio?

#2

Fixed-rate bonds have a greater duration than floating-rate bonds. Thus entering into an interest rate swap to receive fixed-rate (and pay floating-rate) would increase the duration of the portfolio

#2 relates to an equity swap and would not be the most useful (borderline useless?) transaction to affect a portfolio’s duration

#3 would reduce portfolio duration because you are taking a short position in a fixed income security

Hope this helps.