Question

State whether you agree or disagree with the following statement. Explain why.

"If a bond fund manager expects interest rates to go up across all maturities, she should consider lengthening (as opposed to shortening) the duration of the fund's portfolio to benefit from this expectation." (Maximum 3 sentences, maximum 100 words.)

Bonds A and B are both seven-year bonds with annual coupon payments. Bond A has a higher coupon rate and higher yield. Given this information, is it possible to determine which of the two bonds has higher duration (D)? If yes, identify this bond and explain why it has higher duration. If not possible, explain why not.

(Maximum 3 sentences, maximum 100 words.)

Answer 1

- Long Term duration bonds are more sensitive to interest rate changes. Also for every 1% change in interest rate, the bond price will move in opposite direction by 1%. Hence the bond fund manager should shorten the duration of the fund's portfolio if the interest rates are going to go up

- Bonds with higher coupon rate and higher yield have shorter duration. Hence Bond B will have a higher duration. Yield and duration are inversely related. Hence higher the yield, shorter the duration of the bond.