Question

Assume that as an investment manager at Oman investment fund; you hold a large bond portfolio of Omani government bonds (long term) and T-bills (short-terms). The interest rates are currently falling due to Covid-19. i. How your bond portfolio would be affected by falling interest rates?

ii. How your t-bills portfolio would be affected by falling interest rates?

iii. Which portfolio is more sensitive?

Answer 1

ii. The t-bills portfolio will be increasing in value because of the decrease in rates. This can be understood by the formula for pricing bonds. Since yield is in the denominator, the price is going to decrease by an increase in the yield.

iii. The Oman government bond portfolio is more sensitive because it has a country risk premium associated with its yield. The entire world invests in T-bills but that is not the case with the Omani government bonds hence the movement in t-bills is not much as compared to the Omani bonds.