hard · FRM Part 1 Valuation and Risk Models
A manager maintains a duration-matched portfolio to a liability using a barbell strategy (short and long maturity bonds).
After a period of six months with no change in interest rates, how will the portfolio's duration most likely change relative to the liability's duration (assuming the liability is a single lump-sum payment)?
- The portfolio duration will increase because reinvested coupons and principal go into progressively shorter-dated instruments each period.
- The durations remain matched, since the mere passage of calendar time affects every fixed-income instrument's duration identically.
- The liability duration will decrease faster than the portfolio's duration because a single lump-sum payment carries zero convexity by its nature.
- The durations will drift apart because the duration of the barbell portfolio and the bullet liability decline at different rates over time.
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