CPM Fixed Income Portfolio Management 1 — Questions and Answers
Question 1: Duration is primarily used in fixed income portfolio management to measure:
- Credit quality of a bond
- A bond's price sensitivity to changes in interest rates (Correct answer)
- The bond's annual coupon payment
- The bond's time to maturity only
Correct answer: A bond's price sensitivity to changes in interest rates
Duration quantifies the approximate percentage change in a bond's price for a 1% change in interest rates, making it the primary measure of interest rate risk.
Question 2: If a bond portfolio manager expects interest rates to rise, the appropriate adjustment would be to:
- Increase portfolio duration
- Decrease portfolio duration by shifting to shorter-maturity bonds (Correct answer)
- Add more long-term bonds
- Eliminate all cash positions
Correct answer: Decrease portfolio duration by shifting to shorter-maturity bonds
Shortening duration reduces interest rate sensitivity, so when rates rise, the portfolio loses less value than it would with a longer duration.
Question 3: Convexity in a bond portfolio measures:
- The linear relationship between price and yield
- The curvature of the price-yield relationship, improving duration's accuracy for large rate moves (Correct answer)
- The bond's credit rating
- The portfolio's dividend yield
Correct answer: The curvature of the price-yield relationship, improving duration's accuracy for large rate moves
Convexity captures the non-linear (curved) relationship between bond prices and yields, providing a more accurate estimate of price changes for large interest rate movements than duration alone.
Question 4: A bullet portfolio strategy concentrates bond maturities around a single target date, while a barbell strategy:
- Also concentrates maturities at one date
- Splits holdings between very short-term and very long-term maturities (Correct answer)
- Holds equal weights across all maturities
- Focuses exclusively on floating rate bonds
Correct answer: Splits holdings between very short-term and very long-term maturities
A barbell strategy holds bonds at two maturity extremes (short and long), providing flexibility and potentially higher yields than a bullet portfolio with similar overall duration.
Question 5: Spread duration measures a bond portfolio's sensitivity to changes in:
- Risk-free interest rates
- Credit spreads (Correct answer)
- Foreign exchange rates
- Inflation expectations
Correct answer: Credit spreads
Spread duration quantifies the price impact of a change in credit spreads, helping managers assess credit risk exposure separately from interest rate risk.
Question 6: Which of the following best describes an immunized bond portfolio?
- A portfolio invested only in government bonds
- A portfolio structured so that assets and liabilities have matching durations, protecting against interest rate changes (Correct answer)
- A portfolio with zero credit risk
- A portfolio with the highest possible yield
Correct answer: A portfolio structured so that assets and liabilities have matching durations, protecting against interest rate changes
Immunization aligns the duration of assets with the duration of liabilities, ensuring that changes in interest rates affect both sides equally and protect the funding status.
CPM Fixed Income Portfolio Management 1
Duration is primarily used in fixed income portfolio management to measure: