You are a bond portfolio manager. You believe that the economy is stronger than government officials...

You are a bond portfolio manager. You believe that the economy is stronger than government officials have forecast and the Federal Reserve will soon respond with an increase in interest rates unanticipated by the market. Should you increase, decrease, or not change the duration of your bond portfolio given your expectation of an interest rate hike? Explain.

Expert Solution

Duration of a bond portfolio will always be having an INVERSE relationship with change in the interest rates so in this case, it can be seen that when the economy has gone stronger and Federal Reserve will likely increase the interest rate, it will mean that the duration of the bond portfolio is going to decrease after there will be an increase in the interest rate and the bond manager should try to increase the duration of the bond portfolio in order to synchronise with the original allocation so when the interest rate will be increasing the duration of the portfolio of Bond will be decreasing and the portfolio manager of the bond will be trying to to reduce the increase the overall duration of the bond portfolio in order to synchronise with the original duration.

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