The November 26, 1990, issue of BondWeek includes an article, "Van Kampen Merritt Shortens." The article begins as follows:

"Peter Hegel, first V.P.

at Van Kampen Merritt Investment Advisory, is shortening his $3 billion portfolio from 110% of his normal duration of 6½ years to 103–105% because he thinks that in the short run the bond rally is near an end."

Explain Hegel's strategy and the use of the duration measure in this context.

If Hegel thinks the bond rally is over it implies that he thinks bond prices will not go up. This implies the belief that Hegel thinks interest rates will stop falling.

If interest rates begin going up then one does not want to lock in longer-term bonds at lower rates. This implies you want your portfolio of bonds to focus more on shorter-term bonds. Thus, you want a portfolio with a shorter duration. A shorter duration will mean not only less sensitivity to interest rates but if interest rates go up then Hegel will later capitalize on this because as bonds in his portfolio mature quicker (than would be achieved with a portfolio with a higher duration) he will be able to buy new bonds and lock in higher rates.

In brief, Hegel uses the duration measure to optimize the value of his portfolio based upon his belief about how interest rates change.