Which type of investment strategy benefits from a flattening yield curve?

A butterfly strategy is particularly suited to benefit from a flattening yield curve because it involves taking advantage of the price changes of bonds with differing maturities. In a butterfly strategy, an investor typically positions themselves in bonds of shorter and longer maturities while maintaining a neutral position in the intermediate maturity segment. When the yield curve flattens, the prices of the intermediate-term bonds usually increase relative to both short-term and long-term bonds. This results in a wider profit margin for the investor who implemented the butterfly strategy, as the intermediate bonds outperform the other segments of the yield curve.

Understanding the shape of the yield curve is central to applying this strategy effectively. A flattening yield curve indicates that the yield difference between short- and long-term maturities is decreasing. Investors employing a butterfly strategy can thus capture the potential gains from the different price movements across these maturities as the yield curve shifts. This makes it an advantageous approach during times of flattening, as it capitalizes on changes in interest rates across the maturity spectrum.