Level III Core · Overview of Fixed-Income Portfolio Management

Yield Curve Strategies and Credit Strategies for CFA Level III

Updated 9 October 2026 · Fact-checked

Yield curve strategies position a bond portfolio along maturities using bullet, barbell or ladder structures, or ride the curve for roll-down return. Credit strategies adjust exposure to spreads, sectors and issuers. To solve a question, state the view, match the structure to it, and check duration and convexity.

Understand Yield Curve Strategies and Credit Strategies

A yield curve strategy decides where on the maturity spectrum you hold bonds. A credit strategy decides how much credit risk you hold and in which sectors and issuers. Both aim to add return over the benchmark, so both are active choices.

Three structures matter. A bullet portfolio concentrates holdings around one maturity. A barbell holds short and long maturities and nothing in the middle. A ladder spreads holdings roughly equally across maturities. You can build a bullet and a barbell with the same duration. They still behave differently when the curve changes shape, because the barbell has higher convexity and its cash flows are more spread out in time.

The barbell usually has higher convexity than a duration-matched bullet. Higher convexity helps when yields move a lot in either direction. But convexity is priced in, so on an upward-sloping curve the barbell often gives up yield. The barbell is also more exposed to curve twists and steepening or flattening. Define flattening as a narrowing of the spread between long and short yields. It can come from short yields rising or from long yields falling. Steepening is a widening of that spread. For a duration-matched pair, a flattening (long yields falling relative to short yields) favours the barbell, and a steepening favours the bullet. The result depends on where the curve pivots and on whether the move is parallel. Always reason about which part of the curve moves and where the pivot is.

Riding the yield curve (roll-down) works when the curve is upward sloping and you expect it to stay unchanged. You buy a bond with a maturity longer than your horizon. As time passes, the bond rolls down to a shorter maturity, where yields are lower, so its price rises. Your return is the yield carry plus this roll-down gain. It fails if the curve rises or flattens enough to offset the gain. A ladder gives steady reinvestment at different rates, lower reinvestment risk concentration and easy liquidity, but it makes no strong view.

Credit strategies work with credit spreads: the yield above a government or benchmark rate. If you expect spreads to tighten, you overweight credit, move down in quality, or add spread duration. If you expect widening, you cut credit, move up in quality or shorten spread duration. You also choose sectors (for example financials versus industrials), issuers and bonds on the curve. Spread changes hurt lower-quality bonds most, and spreads often widen when liquidity is poor. Tie every position to the client's objectives, risk limits and benchmark tracking-error tolerance.

Key rules to remember

Return from riding the yield curve (approx.): Total return ≈ yield carry over the horizon + roll-down price gain, where roll-down gain ≈ (change in yield from rolling) × modified duration at the horizon × (−1); Assumes an unchanged curve. Yield falls as the bond rolls to a shorter maturity, so price rises. Use the duration of the bond at the horizon.
Price change approximation: %ΔP ≈ −ModDur × ΔY + ½ × Convexity × (ΔY)²; Shows why higher convexity (barbell) helps when yield changes are large.
Credit spread: Spread = bond yield − benchmark yield of similar maturity; Spread tightening raises bond prices. Spread widening lowers them.
Spread price impact (approx.): %ΔP ≈ −SpreadDur × ΔSpread; Use spread duration, not only interest rate duration, for credit exposure.
Duration of a portfolio: Portfolio duration = Σ (weight × duration of each holding); Use it to build a barbell with the same duration as a bullet.

How to solve Yield Curve Strategies and Credit Strategies questions

Use this order for any yield curve or credit strategy question.

1Read the client's objectives, constraints, benchmark and tracking-error limits.
2Identify the view: parallel shift, steepening, flattening, twist, stable curve, or spread tightening or widening.
3Choose the structure that fits: bullet, barbell, ladder, roll-down, or credit over- or underweight.
4Match duration to the benchmark unless the view calls for a duration bet.
5Calculate carry, roll-down, price change or spread effect, and show each number.
6Compare convexity, liquidity and reinvestment risk of the options.
7State the recommendation, then name the main risk if the view is wrong.

Quickest way: View, structure, risk

When to use it: Use for multiple-choice questions that ask which portfolio gains or loses under a given curve or spread change.

Write the view in one phrase, such as 'curve flattens' or 'spreads widen'.
Locate which maturities see yield falls (price gains) and which see rises.
Pick the portfolio with more weight where prices gain.
For large parallel moves, favour higher convexity (barbell).
For credit, widening hurts high-yield and long spread duration most.
Eliminate options that break the client's constraints.

Common mistakes in Yield Curve Strategies and Credit Strategies

Saying a barbell always beats a bullet with equal duration.
Students remember that barbells have higher convexity.
Fix: Convexity is priced in and the barbell gives up yield. Result depends on the shape change and size of the yield move.
Assuming roll-down gains occur when the curve is flat or inverted.
Students memorise the strategy without the condition.
Fix: Roll-down needs an upward-sloping curve that stays unchanged. A flat curve gives no roll-down gain.
Ignoring the horizon when riding the curve.
Students focus on the bond's maturity.
Fix: Buy a bond longer than the horizon and compute value at the horizon at the rolled-down yield.
Using interest rate duration for credit risk.
Both are labelled duration.
Fix: Use spread duration for spread changes. Treat them as separate risks.
Recommending a credit overweight without checking constraints.
Students chase yield.
Fix: Check risk tolerance, liquidity needs and tracking-error limits first, then justify the position.

Worked examples

Example 1

A manager holds a 5-year bond yielding 3.00%. The curve is upward sloping and expected to stay unchanged. The 4-year yield is 2.60%, and the 4-year bond has a modified duration of about 3.7. The horizon is one year. Estimate the total return over the year, using yield carry plus roll-down price gain.

Show the solution

Yield carry over one year ≈ 3.00%.
Yield change from rolling down: 2.60% − 3.00% = −0.40%.
Roll-down price gain ≈ −ModDur × ΔY, using the duration of the bond at the horizon (the 4-year bond), 3.7.
Gain = −3.7 × (−0.40%) = +1.48%.
Total return ≈ 3.00% + 1.48% = 4.48%, or about 4.5%.

Answer: About 4.5% for the year (4.48%), assuming the curve is unchanged.

Example 2

A client with a benchmark of intermediate bonds expects spreads on corporate bonds to widen by 0.50% over the next quarter. The portfolio has a spread duration of 6 on its credit holdings, which are 40% of the portfolio. Estimate the approximate impact on total portfolio price from the spread change, and state the recommended action.

Show the solution

Impact on credit holdings: %ΔP ≈ −6 × 0.50% = −3.00%.
Weight by 40%: −3.00% × 0.40 = −1.20% on the whole portfolio.
Action: widening hurts credit, so reduce the credit weight or spread duration, or move up in quality.
Check constraints: cutting credit lowers yield and may raise tracking error against the benchmark, so keep the underweight within the stated limit.

Answer: Approximately −1.20% on the portfolio. Recommend reducing credit exposure within tracking-error limits.

Exam tips

For essay questions, show the calculation lines. A correct number alone earns credit, but working protects marks if the number is wrong.
Read command words such as 'calculate', 'justify' and 'recommend'. Give only the number of reasons asked for.
State the curve move first, then the portfolio effect. This answers most item-set questions quickly.
Link the strategy to the client's constraints in one sentence when the question asks you to justify.
There is no penalty for wrong answers, so answer every multiple-choice question.

Yield Curve Strategies and Credit Strategies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Yield Curve Strategies and Credit Strategies: frequently asked questions

What is the difference between a barbell and a bullet portfolio?

A bullet holds bonds clustered around one maturity. A barbell holds short and long maturities and none in the middle. With equal duration, the barbell usually has higher convexity and less yield.

How does riding the yield curve work?

You buy a bond longer than your horizon on an upward-sloping curve. As it ages it rolls to a shorter maturity with a lower yield, so its price rises. Your return is carry plus this gain if the curve does not change.

Why use a ladder portfolio?

A ladder spreads maturities evenly. It gives regular cash flows for reinvestment, steady liquidity and lower sensitivity to one rate move. It does not express a strong view on the curve.

What are credit strategies in fixed-income portfolios?

They adjust exposure to credit spreads, quality, sectors and issuers. You add credit if you expect spreads to tighten and cut it if you expect widening, within the client's risk limits.