How do I use key rate durations to position for yield curve twists?

Question

AcadiFi · Accepted Answer

Key rate duration (KRD) measures a portfolio's price sensitivity to a change in yield at a specific maturity on the curve, holding all other rates constant. Summing KRDs across key maturities reconstructs effective duration — but KRDs reveal where along the curve exposure sits. A portfolio with effective duration 7 years could have KRDs of {2y: 0.5, 5y: 1.2, 10y: 3.0, 30y: 2.3} — total 7. Another portfolio with the same 7 effective duration might have {2y: 2.5, 5y: 2.0, 10y: 1.5, 30y: 1.0} — drastically different sensitivities to a twist. For a curve steepener bet (long-end rates rising more than short-end), reduce 30y KRD and increase 2y KRD. The portfolio becomes less sensitive to the 30y rise and more sensitive to the 2y — profiting if the curve steepens as expected, remaining duration-neutral overall. ```mermaid flowchart LR A[Curve View:
Steepener] --> B[Cut 30y KRD] A --> C[Add 2y KRD] B --> D[Net Duration
Unchanged] C --> D ``` For a butterfly (bet on belly richening): short wings (2y, 30y), long belly (10y). Adjust KRDs accordingly — KRD(10y) increases, KRD(2y) and KRD(30y) decrease, while total duration stays constant. Implementation: use cash bonds, futures, or swap positions at specific maturities to hit target KRDs. Rebalance as curve moves because KRDs shift as yields change. Effective duration alone misses twist risk entirely — two portfolios with equal effective duration can have opposite twist exposures. KRD analysis is essential for active curve positioning.

How do I use key rate durations to position for yield curve twists?

Master Level II with our CFA Course

Related Questions

Practice Questions