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Regarding the effects of interest rate shift on fixed-income portfolios with similar durations,which of the following statements is not wrong?
A. A barbell portfolio has greater convexity than a bullet portfolio because convexity increases linearly with maturity.
B. A barbell portfolio has greater convexity than a bullet portfolio because convexity increases with the square of maturity.
C. A barbell portfolio has lower convexity than a bullet portfolio because convexity increases with the square of maturity.
D. A barbell portfolio has lower convexity than a bullet portfolio because convexity increases linearly with maturity.
Answer: B
The statement compares two portfolios with the same duration. A barbell portfolio consists of a combination of short-term and long-term bonds. A bullet portfolio has only medium-term bonds. Because convexity is a quadratic function of time to wait for the payments, the long-term bonds create a large contribution to the convexity of the barbell portfolio, which must be higher than that of the bullet portfolio.
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