The Following Information Relates to Questions
Katsuko Zhao and Johan

Essay

The following information relates to Questions
Katsuko Zhao and Johan Flander are portfolio managers with cowiler investments, a uS-Mbased company. They are assessing the effect of their yield curve forecasts on their bond port- folios. The yield curve is currently upward sloping. Zhao's portfolio is currently invested in uS treasury securities. Zhao forecasts an instanta- neous parallel downward shift in the yield curve. Zhao considers two alternatives to reposition her current portfolio given her yield curve forecast and assesses the trade-off between convexity
and yield. exhibit 1 presents allocations for the current and two alternative portfolios. The durations of the current and alternative portfolios are closely matched.
$\begin{array}{l}\text { EXHIBIT } 1 \text { Allocations for Current and Alternative Portfolios }\\\begin{array} { l c c c } \hline \text { Remaining Term } & \text { Current } & \text { Alternative 1 } & \text { Alternative 2 } \\\hline 2 \text { years } & 33.33 \% & 0.00 \% & 50.00 \% \\10 \text { years } & 33.33 \% & 100.00 \% & 0.00 \% \\20 \text { years } & 33.33 \% & 0.00 \% & 50.00 \% \\\hline\end{array}\end{array}$
-Determine which alternative portfolio in exhibit 1 would be most appropriate for Zhao
given her yield curve forecast. Justify your selection.
template:
Determine which alternative portfolio in exhibit 1 would be most appropriate for Zhao, given her yield
curve forecast. (circle one)
alternative 1 alternative 2
Justify your selection.
based on Zhao's forecast of an instantaneous parallel downward shift in the yield curve,
she also considers selling a portion of the uS treasury securities in her portfolio and buying
one of the following two investments:
investment 1 a mortgage-backed security (MbS)
investment 2 a near-the-money call option on 20-year treasury bond futures
The effective duration of the resulting portfolio will be closely matched to Zhao's current
portfolio.