Question

True, False, or Uncertain and Explain.

(a) Suppose that you want to invest $1,000 in a Treasury bond with 10 years to maturity. Two are available, one with a coupon rate of 6%, and the other with a coupon rate of 11%. If you expect to hold the bond until maturity, buying the 6% bond reduces the riskiness of your total return (relative to buying the 11% bond).

(b) In a volatile interest rate environment, a barbell strategy can usually be expected to outperform a bullet strategy.

Answer 1

a]

False.

All else equal, bonds with higher coupon rates have lower interest rate risk because a higher proportion of the bond's total cash flows are received earlier.

Therefore, in this case, the 6% bond has higher risk than the 11% bond.

b]

True.

A barbell strategy has bonds of short term and long term maturities whereas a bullet strategy has bonds of the same maturity. In a volatile interest rate environment, a barbell strategy can usually be expected to outperform a bullet strategy because the maturities of the bonds are diversified. The bonds are concentrated around in a single maturity in case of a bullet strategy, which means that the portfolio losses will be potentially higher in case of a rise in yields.