How does 'riding the yield curve' work and can it be combined with immunization?

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AcadiFi · Accepted Answer

'Riding the yield curve' (or 'rolling down') is a strategy that profits from the PASSAGE OF TIME combined with an UPWARD-SLOPING YIELD CURVE. When the curve is steep, holding a longer bond and selling it before maturity captures not only the coupon but also the price appreciation from moving to a shorter, lower-yielding point on the curve. Mechanics: Suppose the yield curve is: - 1-year: 3.5% - 2-year: 4.0% - 3-year: 4.5% - 5-year: 5.0% An investor buying a 5-year bond and holding for 2 years will, absent curve changes, see the bond 'roll down' to a 3-year bond yielding 4.5%. Since its yield dropped (5.0% → 4.5%), its price rose — a capital gain on top of the 5% coupon. Worked example: Hollyhock Capital buys a 5-year, 5% coupon bond at par (100) when 5-year rate is 5%. After 2 years, assume the curve is unchanged. The bond is now a 3-year, 5% coupon trading at a 3-year yield of 4.5%. Price = PV at 4.5% ≈ 101.37. Total return = 5% coupon + 0.69% annualized capital gain ≈ 5.69% per year — vs. the 3.5% one-year rate available. Risk: curve flattening or an upward shift wipes out rolldown gains. Rolldown only works when: 1. Curve remains upward-sloping. 2. Curve doesn't shift materially up. 3. Investor has flexibility to sell before maturity. Can it be combined with immunization? Yes — partially. Immunization sets duration = horizon. But you can choose WHICH bonds to use to hit that duration. Choosing bonds on a steep part of the curve (where rolldown is maximum) improves yield without changing duration. This is a form of active yield curve positioning inside a passive immunization structure. ```mermaid flowchart LR A[Buy 5y
at 5.0%] --> B[Hold 2y] B --> C[Now 3y
yields 4.5%] C --> D[Price up
capital gain] ``` CFA L3 tests rolldown both as a pure strategy and as an enhancement to immunization.

How does 'riding the yield curve' work and can it be combined with immunization?

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