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FRM Part I · FRM Exam Part I · Applying Duration, Convexity, and DV01

A portfolio is hedged against parallel shifts using a single 10-year zero-coupon bond so that the portfolio DV01 is zero. The portfolio consists of liabilities concentrated at the 2-year and 30-year maturities. Which risk remains most significant?

The remaining risk is non-parallel curve shifts such as steepening or flattening. A single DV01 hedge only offsets parallel moves, while the barbell exposures at 2 and 30 years differ from the 10-year hedge instrument at each key rate, so twists leave unhedged gains or losses.

  1. AExposure to non-parallel shifts such as a curve steepening or flatteningCorrect
  2. BExposure to a parallel shift in all yields of 1 basis point
  3. CExposure to the portfolio's own modified duration being negative
  4. DExposure to reinvestment of coupons on the 10-year zero-coupon bond

Explanation

A zero DV01 only neutralizes parallel shifts. A barbell of 2-year and 30-year exposures hedged with a 10-year bond has different key rate DV01s at each point, so twists in the curve cause gains or losses. Key rate durations reveal this. A parallel move is already hedged, and a zero-coupon bond has no coupons to reinvest.

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