Explanation

When there is a LARGE parallel shift in the yield curve, the bullet portfolio outperforms the barbell portfolio.

Key Concepts:

• Barbell Strategy: Invests in short-term and long-term bonds, avoiding intermediate maturities
• Bullet Strategy: Concentrates investments in bonds with similar maturities (typically intermediate-term)

Why Bullet Outperforms with Large Parallel Shifts:

1. Convexity Effect:

   • Barbell portfolios typically have higher convexity due to the combination of short and long duration bonds
   • Higher convexity is beneficial for non-parallel yield curve shifts and small parallel shifts
   • However, for large parallel shifts, the higher convexity of barbell portfolios becomes less advantageous

2. Duration Matching:

   • When comparing barbell vs bullet strategies with the same duration
   • For large parallel shifts, the bullet portfolio's concentrated maturity structure provides better performance

3. Price Sensitivity:

   • Large parallel shifts affect all maturities equally
   • The bullet portfolio's focused maturity structure results in more predictable price behavior
   • Barbell portfolios may experience offsetting effects between short and long positions

Mathematical Insight:

The performance difference relates to the second-order effect of convexity. While barbells have higher convexity (beneficial for small changes), for large parallel shifts, the linear duration effect dominates, making bullet strategies more effective.

Answer: B - Bullet outperforms barbell