Question

If the benchmark duration is 2, what duration are you targeting in a falling rate environment?   Why?

Answer 1

Duration is the amount of time, in years, it takes for an investor to be repaid the bond’s price by the bond’s total cash flows. It also is a measure of sensitivity of a bon's  price to changes in interest rates. Since the benchmark duration is 2 , the interest rate risk would be higher ( higher the duration, greater the interest rate risk ). In this case, if interest rates fall by 1%, the prices of the bond would rise 2%. Since, higher the duration , higher the increase in price of the bond in case of a falling rate environment, investors should target bonds with the highest duration in order to get the highest rate of return.