BAFI6010 · Advanced Investment Management
Characteristics of Traditional Assets
Characteristics of Traditional Assets is Topic 4 of BAFI 6010 — the building blocks the strategic asset allocation is actually implemented with, once the objectives, MPT allocation and risk budget are set. It has two halves: fixed income (the yield curve and its macro drivers, Macaulay and modified duration, convexity, credit quality, and bullet-versus-barbell positioning) and equities (capitalisation across the economic cycle, and value-versus-growth styles). The exam rewards the direction of each relationship — how price moves with yield, how duration reacts to coupon and maturity, why the barbell can beat a duration-matched bullet — far more than raw arithmetic, and the mid-semester test is closed-book with no formula sheet, so every formula must be recalled from memory.
What this chapter covers
- 011. Yield curve & shapes — normal (up), flat, inverted (down); inversion as a recession signal
- 022. What sets rates — central bank anchors the short end; trading & issuance set the long end
- 033. Macaulay duration — PV-weighted average time to cash flows, D = Σ t·PV(Cₜ) / Price
- 044. Modified duration — D_mod = D / (1 + y/m); price change ΔP/P ≈ −D_mod × Δy
- 055. Duration properties — inverse to coupon & YTM; rises with maturity at a decreasing rate; zero-coupon D = maturity
- 066. Convexity — the curvature correction; more convexity is desirable for a given duration
- 077. Bullet vs barbell — match duration; parallel shift = indifferent; a twist is decided by the long leg
- 088. Equities — large vs small caps across the cycle; value vs growth via P/E and book-to-market
Duration-matched barbell weights, and why the barbell can win
- +1A zero-coupon bond's duration equals its maturity, so the bullet's duration is 7 (the target the barbell must match).
- +1Set the barbell's duration equal to 7 using the weighted average: w·4 + (1 − w)·16 = 7, where w is the short-leg weight.
- +1Solve: 4w + 16 − 16w = 7, so −12w = −9 and w = 0.75 (short leg), giving 0.25 on the long leg.
- +1Check: 0.75 × 4 + 0.25 × 16 = 3 + 4 = 7 ✓ — note the shorter leg carries the larger weight because the long leg supplies so much duration per dollar.
- +1Reason 1 (convexity): the barbell spreads cash flows to the extremes of the curve, so it has greater convexity than the single-maturity bullet — it gains more when yields fall and loses less when they rise.
- +1Reason 2 (curve shape): the barbell also benefits from a flattening / twist in the curve, which duration-matching alone does not equalise — hence it beat the bullet despite equal duration.
Key terms
- Yield curve (term structure)
- A plot of yield against maturity, built from government bonds. Normal = upward-sloping (expansion); flat = a turning point; inverted = downward-sloping, a classic leading indicator of recession as markets price rate cuts.
- Macaulay duration
- The present-value-weighted average time to a bond's cash flows, D = Σ t·PV(Cₜ) / Price — a measure of interest-rate sensitivity. A zero-coupon bond's duration equals its maturity; a coupon bond's is less.
- Modified duration
- Macaulay duration divided by (1 + y/m), giving the approximate percentage price change per unit yield move: ΔP/P ≈ −D_mod × Δy. Forgetting the (1 + y) denominator is the most common exam slip.
- Convexity
- The curvature correction to duration's straight-line estimate. Because the price-yield curve bows toward the origin, more convexity is desirable: for a given duration the price falls less when yields rise and rises more when they fall.
- Bullet vs barbell
- A bullet concentrates cash flows at one maturity; a barbell splits them between a short and a long leg. Duration-matched, they are indifferent under a parallel yield shift, but a twist is decided by the barbell's long leg.
- Yield-curve twist
- A non-parallel reshaping of the curve. Flattening (long-end yields fall) makes a duration-matched barbell outperform; steepening makes it underperform.
- Value vs growth
- Two active equity styles. Growth buys firms expected to grow EPS fast (high P/E, low book-to-market), betting the market under-appreciates future earnings; value buys firms priced below fundamental value (low P/E, high book-to-market), betting on a re-rating.
- Book-to-market (B/M)
- Book value divided by market value — a relative-value gauge. High-prospect firms carry lower B/M (and higher P/E); distressed or cheap firms carry higher B/M, the classic value signal.
Characteristics of Traditional Assets FAQ
What does an inverted yield curve signal?
An inverted (downward-sloping) curve, where short yields sit above long yields, is a classic leading indicator of recession — it reflects markets pricing in future rate cuts as growth slows. A normal upward curve signals expansion; a flat curve often marks a turning point.
What is the difference between Macaulay and modified duration?
Macaulay duration is the present-value-weighted average time to a bond's cash flows (measured in years). Modified duration = Macaulay / (1 + y/m) and converts that into an approximate percentage price change per unit yield move, ΔP/P ≈ −D_mod × Δy. Dropping the (1 + y) denominator is a frequent mistake.
Why can a barbell beat a duration-matched bullet?
Duration-matching only equalises first-order (linear) sensitivity, so the two tie under a parallel shift. The barbell still wins on two fronts: it has greater convexity (its cash flows sit at the curve's extremes), and it benefits from a curve flattening or twist through its long leg — neither of which duration-matching removes.
Is convexity a good or bad thing?
Convexity is desirable. Because the true price-yield relationship is convex (bowed toward the origin), for a given duration more convexity means the price falls less when yields rise and rises more when they fall. Calling convexity 'bad' is a classic exam error.
How does the exam test Topic 4?
Expect a fixed-income calculation (price a bond, find Macaulay and modified duration, estimate the price change and compare with the exact reprice to expose the convexity gap), a bullet-versus-barbell weights-and-reasoning question, and short-answer discussion on yield-curve shapes, the duration properties, cap cyclicality and value-versus-growth logic. The mid-semester test is closed-book with no formula sheet.
Is this page official or affiliated with the University of Adelaide?
No. This is an independent AskSia study resource to help students revise. It is not produced, endorsed by, or affiliated with the University of Adelaide, and it is not a substitute for the official Canvas materials and course outline.
Exam move
Learn Topic 4 as a set of directions first, then the arithmetic. For fixed income, drill one duration-and-convexity question end to end — discount the cash flows to a price, compute Macaulay and modified duration, estimate the percentage price change, then reprice exactly and name the small gap as convexity (duration always overstates the loss on a yield rise). Memorise the duration properties as a checklist (inverse to coupon and YTM; rises with maturity but at a decreasing rate; zero-coupon duration equals maturity), because the mid-semester test is closed-book with no formula sheet. For bullet-versus-barbell, practise the weight algebra until it is automatic, but rehearse the reasoning even harder: parallel shift means indifferent, a twist is decided by the long leg, and the barbell always carries more convexity. On the equity side, fix the cyclicality (small caps near the bottom, large caps near the top) and the value-versus-growth contrast (value bets on a re-rating of cheap or distressed firms; growth bets on under-priced future EPS). Finish every numerical answer with one sentence of interpretation — the direction and what it means — because that applied judgement is where most of the marks sit.
