Consider three bonds, X, Y and Z. Bond X has a yield of 8% and a maturity of 5 years; it can be held in one portfolio, called a bullet portfolio. Bonds Y and Z have 3 and 8 years to maturity and yields to maturity of 7% and 8%, respectively. Answer the questions below.

a. Construct a barbell portfolio with bonds Y and Z assuming equal weights. Compute the portfolio’s average yield.

b. If yields increase by 50 basis points across all maturities, what would be the portfolio’s average rate of return? Compare the bullet and barbell portfolios’ yields after the yield change. Comment.

c. If yields decrease by 50 basis points across all maturities, what would be the portfolio’s average rate of return? Compare the bullet and barbell portfolios’ yields after the yield change. Comment.

d. Now assume an even 200-basis point increase in yields. Which portfolio would fare better?