101 Concepts for the Level I Exam
Essential Concept 63: Riding the Yield Curve or Rolling Down the Yield Curve
- Active bond portfolio managers can outperform the bond market’s return by correctly anticipating changes in interest rates relative to the projected evolution of spot rates.
- When a yield curve is upward sloping, the forward curve is always above the current spot curve. If a trader does not believe that the yield curve will change its level and shape over an investment horizon, he will buy bonds with a maturity longer than the investment horizon. This strategy is called riding the yield curve or rolling down the yield curve.
- If the view is correct, the trader’s total return will be greater than the return on a maturity-matching strategy.
- The total return will depend on the spread between the forward rate and the spot rate as well as the maturity of the bond. The longer the bond’s maturity, the more sensitive its total return is to the spread.