Yield Curve Question (simple i hope).

[BaseballRedhawks]

Here’s the question:
The pension plan has a benchmark that has a duration of 5.6. None of the bonds in the portoflio have embudded options. However’s the pension’s liability has a duration of 10.2 creating an asset liability mismatch for the pension fund. THe actual portfolio has a duration of 6.2
Given the term structure of interest rates and the duraiton mismatch between the benchmark and its liabilities, 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.
Can someone people help explain the answer? (A)? A flattening of the yield curve would cause the liability to increase faster than the asset.
Does this mean interest rates decline? If interest rates decline, you want a higher duration for assets so that does make sense.
Any thoughts would be highly appreciated.
Thanks!

 

[cpk123]

flattening of the yield curve is either shorter term rates rising or longer term rates falling.
if shorter term rates rise - asset values fall - with a shorter duration.
if longer term rates fall - liability becomes bigger than the asset as well.
in either case the liab is increasing faster than the asset.
does this make sense?

 

[sachin_patel]

yes.. thank you!

 

[BaseballRedhawks]

Thanks!

 

[BaseballRedhawks]

Do we always assume that the yield curve is upward sloping and that is the norm?
If the yield curve was inverted.. then a flattening would be ST rates going down, and long term rates going up……

 

[S2000magician]

BaseballRedhawks wroteo we always assume that the yield curve is upward sloping and that is the norm?
If the yield curve was inverted.. then a flattening would be ST rates going down, and long term rates going up……

That makes sense intuitively, which pretty much guarantees that that’s not how bond people see it.
To bond people, flattening means rotating clockwise (deasil), and steepening means rotating counterclockwise (anticlockwise, widdershins).
There you go.

 

[kfp22]

In this question, is the “benchmark” duration a piece of useless information that intends to confuse you?
If the actual portfolio’s duration is 6.2, do we simply consider the plan’s asset’s duration being 6.2?

 

[zulu007]

Thanks