Question

Why does the theory assume an upward sloping yield curve? If the yield curve is upward sloping and we expect it to steepen following an increase in long term rates and decrease in short term rates, would it be more beneficial to hold a bullet (focused) or a barbell bond portfolio? Explain

Answer 1

An upward sloping curve generally indicates that the financial markets expect higher future interest rates . A downward sloping curve indicates expectations of lower rates in the future, the slope of the yield curve provides an important clue to the direction of future short-term interest rates. The overall level of the yield curve also may shift up or down—at least in part because of changes in inflationary expectations over time.

Bullet vs. Barbell Strategies:

Barbell strategy

Barbell strategy is formed when a trader invests in long- and short-duration bonds, but does not invest in intermediate-duration bonds. This strategy is useful when interest rates are rising; as the short term maturities are rolled over they receive a higher interest rate, raising the value.

Maturities of securities are concerned at two extreme maturities. Therefore, instead of investing in intermediate duration bonds, the barbell method urges investors to favor a combination of short duration (under three years) and long duration (more than ten years) bonds.

Bullet Strategy

An investor who uses a bullet strategy purchases several bonds that mature at the same time. By targeting this specific maturity, the investor aims to invest in a particular segment of the yield curve

Maturities of securities are concerned around one point on the yield curve.

Hence, If the yield curve is upward sloping and we expect it to steepen following an increase in long term rates and decrease in short term rates, would it be more beneficial to hold a bullet (focused)

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