Why does a barbell portfolio have higher convexity?

Convexity is a second-order effect describing a bond’s price behavior for larger rate movements and is affected by cash flow dispersion. A barbell portfolio combining short- and long-term bond positions will have greater convexity than a bullet portfolio concentrated in a single maturity for a given duration.

Why would an investor choose to hold bond portfolios with more convexity than other investors?

However, the relationship between bond prices and yields is typically more sloped, or convex. Therefore, convexity is a better measure for assessing the impact on bond prices when there are large fluctuations in interest rates. As convexity increases, the systemic risk to which the portfolio is exposed increases.

What is a high convexity bond?

Pointedly: a high convexity bond is more sensitive to changes in interest rates and should consequently witness larger fluctuations in price when interest rates move. The opposite is true of low convexity bonds, whose prices don’t fluctuate as much when interest rates change.

How do you calculate convexity of a bond portfolio?

So convexity ≈ duration2 + dispersion (variance) of maturity. At current rates, they have the same value and the same slope (duration).

What is a barbell portfolio?

The barbell is a fixed-income portfolio strategy where half of the holdings are short-term instruments and the other half are long-term holdings. The barbell strategy can also mix stocks and bonds. There are several risks associated with using a barbell strategy, such as interest rate risk and inflation risk.

What is bullet bond?

A bullet bond is a debt investment whose entire principal value is paid in one lump sum on its maturity date, rather than amortized over its lifetime. Bullet bonds cannot be redeemed early by their issuer, which means they are non-callable.

What is ladder strategy?

An investment strategy in which one invests in several securities with different maturities. When the first one matures, the yield may or may not be used to buy another security. This practice is also called staggering maturities or liquidity diversification. …

What does bond convexity measure?

As the yield on a bond changes so too does its duration. A bond’s convexity measures the sensitivity of a bond’s duration to changes in yield. Duration is an imperfect way of measuring a bond’s price change, as it indicates that this change is linear in nature when in fact it exhibits a sloped or “convex” shape.

What is the formula for bond convexity?

Calculating Convexity To approximate the change in the bond’s price given a particular change in yield, we add the convexity adjustment to our original duration calculation. Convexity (C) is defined as: C=1P∂2P∂y2. where P is the bond’s price, and y its yield-to-maturity.

What is a barbell bar?

A barbell is a piece of exercise equipment used in weight training, bodybuilding, weightlifting and powerlifting, consisting of a long bar, usually with weights attached at each end.

What is a barbell distribution?

Definition. Barbell distribution is an informal name given to any Probability Distribution that exhibits a range that seems to be a composite of two extreme (separated) domains. A more formal name is Bimodal distribution.

What is the convexity of the barbell portfolio?

The convexity of the barbell portfolio, however, is which is substantially greater than the convexity of the liabilities. A barbell has greater convexity than a bullet because duration increases linearly with maturity while convexity increases with the square of maturity.

What is the barbell strategy for bonds?

Barbell Strategy The barbell strategy is used to take advantage of the best aspects of short-term and long-term bonds. In this strategy only very short-term and extremely long-term bonds are purchased. Longer dated bonds typically offer higher interest yields, while short-term bonds provide more flexibility.

What is the relationship between convexity and risk in bonds?

Convexity and Risk. As convexity decreases, the exposure to market interest rates decreases and the bond portfolio can be considered hedged. In general, the higher the coupon rate, the lower the convexity (or market risk) of a bond. This is because market rates would have to increase greatly to surpass the coupon on the bond,…

What is a barbell strategy in fixed income?

The barbell strategy in fixed income is the opposite of a “bullet” strategy, in which the portfolio is concentrated in bonds of a particular maturity or duration.