A US-based portfolio manager plans to invest in Australian zero-coupon bonds denominated in Australian dollars (AUD). He projects that over the next 12 months, the Australian zero-coupon yield curve will experience a downward parallel shift of 60 bps and that AUD will appreciate 0.25% against USD. The manager is weighing bullet and barbell strategies using the following data:

Solve for the expected return over the 1-year investment horizon for each portfolio using the step-by-step estimation approach in Equation 1.

Transcribed Image Text:

Statistic Investment horizon (years) Average bond price in portfolio (today) Average portfolio bond price (in 1 year/stable yield curve) Expected portfolio effective duration (in 1 year) Expected portfolio convexity (in 1 year) Expected change in AUD zero-coupon yields Expected change in AUD versus USD Bullet 1.0 98.00 99.75 3.95 19.50 -0.60% +0.25% Barbell 1.0 98.00 100.00 3.95 34.00 -0.60% +0.25%