Question

10.2   What is the easiest way to reduce the risk of your bond portfolio (while maintaining a portfolio of exclusively bond investments) against the following kinds of risk? You might want to do a bit of Internet research to answer this question, although it is not absolutely necessary.                                      

a.     Risk of an increasing interest rate

b.    Risk of increasing inflation

c.     Risk of market volatility

Answer 1

1. A. In case of of a rising interest rates , you can buy short term bonds as they are beneficial when the interest rates go up, to hedge your bonds portfolio. They benefit with rise in interest rates as they have shorter duration.

2. Buying TIPS(Treasury inflation protection security) when inflation is expected to up as it also goes up with the inflation & TIPS protect the overall negative impact from inflation rise.

3. When volatility rise, you can buy VIX options to protect your bond portfolio as VIX options is a direct measure of volatility through Volatility indexes. You can also readjust the overall sensitivity of your portfolio by diversification.