Riding the yield curve strategy confusion

CFA Level II Fixed Income
#1

Hey guys,

I came across a question on the CFAI LES, that I have some doubts on:

“Shire Gate Advisers recently published a report for its clients stating its belief that, based on the weakness in the financial markets, interest rates will remain stable, the yield curve will not change its level or shape for the next two years, and swap spreads will also remain unchanged.”

In presenting Investment 1, using Shire Gate Advisers’ interest rate outlook, Smith could show that riding the yield curve provides a total return that is most likely:

1. lower than the return on a maturity-matching strategy.
2. equal to the return on a maturity-matching strategy.
3. higher than the return on a maturity-matching strategy.

Answer: 3
“When the spot curve is upward sloping and its level and shape are expected to remain constant over an investment horizon (Shire Gate Advisers’ view), buying bonds with a maturity longer than the investment horizon (i.e., riding the yield curve) will provide a total return greater than the return on a maturity-matching strategy.”

Isn’t this answer failing to consider expectations of where the spot curve will evolve to? My understanding was the for riding the yield curve strategy to work the spot curve would have to evolve below the original implied forward curve?

#2

Um . . . no:

#3

So which part of that statement alludes to current spot rates not evolving to the implied forward curve?

#4

The part that I bolded and italicized.

#5

Ohh right, so because it’s expected not to change its level and shape for the next two years, it won’t be moving at all towards the forward curve.

#6

Yup.

:racehorse:

#7

How does buying a longer term bond provide a higher return?

#8

With an upward sloping yield curve, higher yield; a combination of coupon and capital gain/loss that’s higher than at shorter maturities.

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