Advanced Fixed Income exercise

Data on benchmark US Tbonds are provided below. Three proposed US Tbond portfolios I, II, III are also shown. Each has the same market value of $500 million but comprises different weights of the benchmark Tbonds. The portfolios differ in key characteristics. Yield to Effective Effective US Benchmarks Coupon % Maturity Duration Convexity US 2 year 2/27/2023 US 3 year 3/15/2024 US 5 year 2/27/2026 US 7 year 2/27/2028 US 10 year 2/15/2031 US 30 year 2/15/2051 Weights in 2-,3-,5-,7-,10-,30-Yr Bonds Ave. YTM Ave. Eff. Dur. Ave, Eff. Conv. Portfolio I (0.15,0.25,0.25,0.15,010,010) Portfolio II (0.70,0.00,0.00,0.00,0.00,0.30) Portfolio III (0.00,0.00,0.20,0.70,0.10,0.00) The scenario over the next year is that 2s-30s spread (30Y T-bond yield minus 2T T-note yield) is expected to widen by 1% with short and intermediate yields falling and longterm yields remaining stable. Under active management, which portfolio should be chosen? Explain your answer by making references to the expected shape of the yield curve, the weighted or average effective duration, effective convexity, and yieldtomaturity of the portfolio