You manage a broadly diversified fixed income portfolio. You

You manage a broadly diversified fixed income portfolio. Your fund management mandate requires that you be fully invested always. That is you cannot sell securities and simply sit on the cash you generate nor do you have cash on hand to invest: the fund is now and must remain fully invested. You are also not permitted to take leveraged positions (i.e. you cannot borrow). Suppose you believe the yield curve is going to become steeper in the coming weeks but you do not have any firm opinion on the question of if the overall yield curve will shift up or down. The portfolio you manage has positions in all 3 bonds listed above. A. Construct a trade using these 3 bonds that is largely insensitive to small parallel shifts in the yield curve but will provide a profit if the yield curve becomes steeper. Assume you transact in 20 million (face value) of the 10-year bond. What position in the 2-year and 30-year bonds must you take? For each of the 3 bonds state if you will buy or sell it and provide the correct par value amount needed to construct the trade. B. Suppose you do the trade you describe in part a). Immediately the yield curve shifts upward but not all yields move the same amount. Specifically the yield on the 2-year rises to 1.60% the yield on the 10-year rises to 2.20% and the yield on the 30-year rises to 2.65%. In dollar terms how much better or worse off is your portfolio for having done this trade (as opposed to having done nothing)?

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