AIM 6: Create a barbell and a bullet portfolio.

1、Immunization is the process of offsetting the effects of interest-rate changes on the value of assets and liabilities. Coverage of liabilities with significant convexity may be more effectively matched with a:

A) mortgage portfolio, especially in a highly volatile rate environment.

B) barbell portfolio with positive convexity.

C) bullet portfolio with little convexity.

D) callable bond portfolio, especially in a declining-rate environment.

The correct answer is B

Barbell portfolios usually contain substantial convexity, which can be used to offset changes in liabilities not met with duration matches.

AIM 7: Analyze the impact convexity may have on a barbell and bullet portfolio.

1、Evaluated at the same yield, the investment that is expected to have the greatest convexity is a:

A) portfolio with a duration of 10 that contains a 5-year zero-coupon bond and a 15-year zero-coupon bond. 

B) callable 6% coupon bond of 10-year duration. 

C) 6% coupon bond of 10-year duration.

D) 10-year zero-coupon bond. 

The correct answer is A

A barbell portfolio will have greater convexity than a bullet portfolio, so convexity of the barbell portfolio is greater than the convexity of the 10-year zero-coupon bond. In general, the higher the coupon, the lower the convexity, so convexity of the 10-year zero-coupon bond is greater than the convexity of the 6% coupon bond of 10-year duration and the callable 6% coupon bond of 10-year duration.