The Following Information Relates to Questions
Katsuko Zhao and Johan

question 17

Essay

The following information relates to Questions
Katsuko Zhao and Johan Flander are portfolio managers with cowiler investments, a uS-Mbased company. They are assessing the effect of their yield curve forecasts on their bond port- folios. The yield curve is currently upward sloping. Zhao's portfolio is currently invested in uS treasury securities. Zhao forecasts an instanta- neous parallel downward shift in the yield curve. Zhao considers two alternatives to reposition her current portfolio given her yield curve forecast and assesses the trade-off between convexity
and yield. exhibit 1 presents allocations for the current and two alternative portfolios. The durations of the current and alternative portfolios are closely matched.
$\begin{array}{l}\text { EXHIBIT } 1 \text { Allocations for Current and Alternative Portfolios }\\\begin{array} { l c c c } \hline \text { Remaining Term } & \text { Current } & \text { Alternative 1 } & \text { Alternative 2 } \\\hline 2 \text { years } & 33.33 \% & 0.00 \% & 50.00 \% \\10 \text { years } & 33.33 \% & 100.00 \% & 0.00 \% \\20 \text { years } & 33.33 \% & 0.00 \% & 50.00 \% \\\hline\end{array}\end{array}$
-Determine which portfolio in exhibit 2 will most likely have the best performance over the next 12 months given Flander's yield curve forecast. Justify your response. Determine which portfolio in Exhibit 2 will most likely have the best performance over the next 12 months given Flander's yield curve forecast. (circle one)

Flander evaluates a new bullet portfolio and a new barbell portfolio, each with a 12-month
time horizon, using zero-coupon notes issued by the australian government. Flander pro- jects that over the next 12 months, the australian zero-coupon yield curve will experience a downward parallel shift of 60 bps. The australian dollar is projected to remain stable relative to the uS dollar. exhibit 3 presents the data for the two portfolios. $$\begin{array}{l}\text { EXНПВ Т } 3 \text { Selected Data for Australian Bullet and Barbell Porrtolios }\\\begin{array} { l c c } \hline & \text { Bullet } & \text { Barbell } \\\hline \text { Investment horizon (years) } & 1.0 & 1.0 \\\text { Average bond price for portfolio currently } & 98.00 & 98.00 \\\begin{array} { l } \text { Average bond price for portfolio in one year } \\\text { (assuming stable yield curve) }\end{array} & 99.75 & 100.00 \\\text { Expected effective duration for portfolio (at the horizon) } & 3.95 & 3.95 \\\text { Expected convexity for portfolio (at the horizon) } & 19.50 & 34.00 \\\text { Expected change in government bond yield curve } & - 0.60 \% & - 0.60 \% \\\hline\end{array}\end{array}$$

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