Relationship between steepness of curve and portfolio IRR

CFA Level III Fixed Income
#1

Hi everyone,

I am currently trying to understand the effects of yield curve changes. The material reads:

Steepening twist (image link: https://imgur.com/a/HzrPk): Yield Low decreases while yield High increase relative to yield Medium. The portfolio market value will decrease because the decline in value of the longer duration bond will exceed the increase in the value of the shorter duration bond. PV of liability will be unchanged with no change in yield Medium. PV of asset is now below PV of liability. That, by itself, does not indicate the strategy will fail. If portfolio IRR increases sufficiently, the required FV might still be reached. ( Recall that portfolio IRR would tend to increase above a single point Medium YTM with a steeper curve ). This indicates that a steepening curve creates structural risk.

Could someone explain the underlined portion? I can’t understand it.

Thank you.

#2

Humble bump? Anyone?

#3

Is this from Fixed Income? What reading in 2018 curriculum?

#4

Yes, this is from fixed income. It is in Reading #22 of Kaplan textbook.

#5

While i am not able to answer your question (specifically around IRR), would recommend you refer to the official CFA readings…FI has been revamped in 2018. This looks alien to me…especially the link to IRR.

IRR has not been mentioned in entire 2018 FI CFA official readings.

Actually in my opnion FI has been explained pretty well (in official curriculum), and i don’t work or have background in FI.

#6

Hi, I think what they’re trying to say is:

  • Steepening could still result in asset returns matching PV(liabilities) if lower yields are higher weighted
  • In any case, irrespective of weighting, it creates structural risk
#7

Wow, if this is how structural risk is explained in third party provider books, i rather stick with official curriculum.

My 2 cents (i know i havent passed this exam)- but structural risk is explained very well & clearly in CFA curriculum.

#8

Thanks everyone, honestly I still don’t get it. I agree that it isn’t well explained and I had to do a ton of googling while reading the material. May try out cfa2014’s suggestion