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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A community bank wants to invest $60 million in bonds. It uses a barbell strategy rather than a bullet strategy, holding both short-term securities and long-term securities but nothing in the intermediate range. Compared with a bullet portfolio of the same duration, which is the main advantage of the barbell?

The barbell's main advantage is that short holdings give liquidity and flexibility to reinvest while long holdings supply yield, and for equal duration it usually has higher convexity than a bullet. It does not remove reinvestment risk or guarantee better results under every yield curve shift.

  1. AIt gives the short end liquidity and reinvestment flexibility while the long end provides yield, and it typically has higher convexityCorrect
  2. BIt eliminates all reinvestment risk because of the long maturities
  3. CIt guarantees a higher yield than the bullet in all yield curve shifts
  4. DIt reduces the portfolio's duration to zero

Explanation

A barbell combines liquid short-term holdings, which can be reinvested if rates rise, with long-term securities that earn higher yield. For the same duration it generally has greater convexity than a bullet. It does not eliminate reinvestment risk and does not guarantee outperformance in every curve shift.

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