Hi all,
hope you can help below.
The solution used maturities to calculated each benchmark’'s weighting. Shouldn’t we use duration to calculate weighting instead? I am getting a different answer if I use duration…
Thanks,
Can you post the entire problem. Unfortunately I don’t have the curriculum material with me.
By the look of it Maturity is the purest form of Duration. This is a pointer. Please reproduce the problem to boil down to the specifics
my apologies - please see the problem set below. The paragraph above this problem set specifically mentioned that the investment manager could hedge interest rate by selling duration-weighted amount of the two benchmark govies…
I understand the confusion and I am with you. This is more of a convention though it is a textbook approach and technically correct.
The core to this problem lies in the basic understanding of Duration measures itself.
Macaulay Duration is your maturity duration . I hope you remember that. In that sense (assuming a non cpn paying bullet z bond security because nothing is mentioned about the cpn, although a slight hint remain in the effective duration) a T sec is best represented by its maturity.
Hence to that extent replicating two barbells around the CItibank issue just to create the benchmark seems perfect. Without flaw. A G spread can only be determined that way.
An Effective Duration is best suited with issues that are not only cpn paying but also the ones embedding optionalities. But for sure T or G secs can NEVER have optionality. So creating the synthetic benchmark considering the Maturity (Macaulay Duration) is perfect.
Pricing the Citibank issue with the new yield and the E.D. is again correct.
Remember Mac. Or Marurity Duration is always highest follows by the other measures.
Hope it is clear.
wow super! it now makes perfect sense to me. Thanks again buddy!
Welcome!
CFAI has a funny penchant for making FI topic convoluted and more difficult than what it is. No wonder people suffer from FI and Risk Management the most. The language and the presentation both are complex. Here’s my 2 cents. Stick with the basics and focus on the core areas of Duration and Weighting. You should be fine.
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