Chartered Financial Analyst (CFA) Practice Exam Level 2

Riding the yield curve involves what strategy?

1. Buying short-term bonds only

2. Selling long-term securities immediately after purchase

3. Buying long-term securities and selling them after a short period

4. Holding onto all securities until maturity

The correct answer is: Buying long-term securities and selling them after a short period

Riding the yield curve is a strategy used by investors to capitalize on the shape of the yield curve, which plots interest rates against different maturities. The correct choice, which involves buying long-term securities and then selling them after a short period, effectively captures the profit from the anticipated decline in interest rates. When investors buy long-term bonds, they typically benefit from higher yields compared to short-term bonds. If interest rates fall after the purchase, the value of these securities increases, allowing the investor to sell them at a profit. This strategy takes advantage of the fact that as you move along the yield curve, longer-term securities tend to provide greater price appreciation when rates fall. The goal is to enter into a position where the expected price appreciation outweighs the risk involved in holding the securities. Investors using this strategy are generally focusing on the shifting dynamics of interest rates rather than simply holding to maturity or only buying short-term bonds. The other approaches do not align with the concept. For instance, only buying short-term bonds misses the potential gains from long-term bonds when rates decline. Selling long-term securities immediately after purchase does not allow for price appreciation and typically results in capturing losses rather than gains. Lastly, holding onto securities until maturity negates the strategy of capital