A portfolio manager believes Canadian inflation will rise unexpectedly, leading to higher interest rates across the yield curve. To position a fixed income portfolio for this scenario, which strategy, focusing on duration, would be most appropriate?

Question: A portfolio manager believes Canadian inflation will rise unexpectedly, leading to higher interest rates across the yield curve. To position a fixed income portfolio for this scenario, which strategy, focusing on duration, would be most appropriate?

Answer options:

• Increase the portfolio's weighted average duration to maximize capital gains.
• Maintain a neutral duration, as interest rate movements are unpredictable. ✅ Decrease the portfolio's weighted average duration to minimize capital losses.
• Shift investments from short-term to long-term bonds to capture higher yields.

Correct answer: Decrease the portfolio's weighted average duration to minimize capital losses.

Explanation: Duration measures a bond's price sensitivity to interest rate changes. When interest rates are expected to rise (or inflation worries increase), bond prices fall. To mitigate potential capital losses, a portfolio manager would decrease the portfolio's duration, making it less sensitive to the anticipated rate increases.