Butterfly Trade It is November 15, 2018.

Consider the following Treasury yield curve:

Maturity YTM Price

2-year 10/31/20 2.00% 100-00

5-year 10/31/23 3.50% 100-00

10-year 10/15/28 4.75% 100-00

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

Portfolio I: 5-year bullet.

Portfolio II: 2-year/10-year barbell.

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

a.) How much is invested in the 2-year and in the 10-year?

2.) Suppose you believe that 9 months from today the 2-year yield will be 50 basis points higher and the 10-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 these questions.