Barbell and Bullet Strategy- Chapter 4 Tuckman

[Unusualskill]

Hi @David Harper CFA FRM ,

May I ask why when manager believes that rates will be especially volatile, barbell portfolio would be preferred over bullet portfolio?

As I know that barbell portfolio has greater convexity? then it means that price changes will be larger. But if thats the case, the price decline will also be larger? Please clarify.

Thank you so much!

 

[Nicole Seaman]

Hi @David Harper CFA FRM ,

May I ask why when manager believes that rates will be especially volatile, barbell portfolio would be preferred over bullet portfolio?

As I know that barbell portfolio has greater convexity? then it means that price changes will be larger. But if thats the case, the price decline will also be larger? Please clarify.

Thank you so much!

Hello @Unusualskill

I just wanted to make sure that you had used the search function, as there are quite a few threads that discuss the barbell portfolio vs. bullet portfolio. Here are a few that I found quickly, which have a lot of discussion in the comments:

• https://forum.bionicturtle.com/threads/l2-t5-31-hedging-with-bullet-versus-barbell-tuckman.3461/
  
• https://forum.bionicturtle.com/threads/question-7-bond-barbell-portfolio.1102/#post-4059
  
• https://forum.bionicturtle.com/threads/l2-t5-30-barbell-convexity-tuckman.3458/#post-9383

There were many other threads that came up in my search also. The example that is in the notes on Pages 80 & 81 (which I assume is the example you are referring to?) also go into detail about this

Nicole

 

[David Harper CFA FRM]

Thanks @Nicole Seaman those are good links! @Unusualskill You are right except for "the price decline will also be larger?" If you are long the bond and long convexity, the convexity helps in both directions: when yields drop, it accelerates the gain; when yield increase, it mitigates the loss per the curvature of the P/Y curve. (if you are short the bond, you are similarly worse of in both directions, so it's important to distinguish between long versus short convexity). For this reason, the basic trade-off is that the long convexity position enjoys a lower yield (per Tuckman's point) for the same duration. But the long convexity (long bond) position does better in high volatility because the convexity helps (adds return, or reduces loss) in both directions. Thanks!

 

[Unusualskill]

@David Harper CFA FRM Thank you David, it is clear when I draw the curves myself. May I clarify when you are talking about short convexity, are you referring to negative convexity where when yield increase, duration increase, the graph will look like y=x^2 where x is positive?

 

[David Harper CFA FRM]

Hi @Unusualskill Interesting! They do have in common that they are concave functions (which is the negative of a convex function), but what I said "short convexity" I have a mind a short position in a bond whose shape which has a price/yield curve (to the short) as shown on the right-hand panel below; the standard convexity works against this short position; e.g., https://forum.bionicturtle.com/threads/short-convexity-gamma.8724

Compared to the "typical" negative convexity of which we speak when the bond embeds a call option (e.g., mortgage/MBS) which creates negative convexity (aka, concavity) at lower yields. I hope that's helpful!