See how our partners can help you ace your CFA exams.
READING 22 - Fixed Income Portfolio Management - Q23 (Source: CFAI)
Q23. Salvatore Choo, the Chief Investment Officer at European Pension Fund (EPF), wishes to maintain the fixed-income portfolio’s active management but recognizes that the portfolio must remain fully funded. The portfolio is run by World Asset Management, where Jimmy Ferragamo, a risk manager, is analyzing the portfolio (shown in Exhibit 1), whose benchmark has a duration of 5.6. None of the bonds in the portfolio have embedded options. However, EPF’s liability has a duration of 10.2, creating an asset liability mismatch for the pension fund."
Given the term structure of interest rates and the duration mismatch between EPF’s benchmark and its pension liability, the plan should be most concerned about a:
A flattening of the yield curve.
B steepening of the yield curve.
C large parallel shift up in the yield curve.
Answer: A is correct. Given the mismatch in the liability and the benchmark they are running against, a flattening of the yield curve would cause the liability to increase faster than the asset.
Can someone explain the answer to me please. I don't quite get it. I understand that if short term rate comes down then the liability obligation will increase. But why a flattening of the yield curve?