Question

As a corporate treasurer, you manage a $100 million bond portfolio. Economists suggest (and you believe) that market interest rates are headed up over the next several months. To reduce interest rate risk you should attempt to: I. Reduce the average maturity of the portfolio by selling long-term bonds and buying short-term bonds. II. Lengthen the average maturity of the portfolio by buying long-term bonds and selling short-term bonds. III. Reduce the average coupon rate by selling high-coupon bonds and buying low-coupon bonds. IV. Increase the average coupon rate by buying high-coupon bonds and selling low-coupon bonds. A) I only B) I and II only C) II and III only D) I and IV only E) I, II, III, and IV
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Answer 1

Now the interests rates are heading up it means we need to invest in high coupon paying bonds and to get funds to invest in such bonds we have to sell low coupon bond in over portfolio. The range of effect of interest rate movement on a bond is dependent on the maturity of the bond if the bond has higher maturity term then the interest effect on such bond will be higher than lower maturity term bond. Thus we need to lower our long term bonds in our portfolio and buy the short term bonds.

I. Reduce the average maturity of the portfolio by selling long-term bonds and buying short-term bonds.

IV. Increase the average coupon rate by buying high-coupon bonds and selling low-coupon bonds.

D) I and IV only

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