Butterfly Trade

It is April 7, 2021.

Consider the following Treasury yield curve:

Maturity Coupon Price

2-year 3/31/2023 2.00% 100-00

6-year 9/30/2026 3.50% 100-00

11-year 9/15/2031 4.75% 100-00

There are 2 portfolios, each with $100MM market value.

Portfolio I: 6-year bullet.

Portfolio II: 2-year/11-year barbell.

1.) Today, you invest the $100MM in each portfolio, so that the portfolios have the same duration. The trades settle tomorrow, April 8.

a.) How much is invested in the 2-year and in the 11-year?

2.) Suppose you believe that 9 months from today the 2-year yield will be 50 basis points higher and the 11-year yield will be 25 basis points lower.

a.) Which strategy outperforms on a total rate of return basis?

3.) Discuss the issues/complexities involved with solving question #2.