Managing Interest Rate Risk in Fixed Income Portfolios

ABC Investment Management has a fixed income portfolio primarily consisting of treasury bonds, municipal securities, and corporate debt. Recently, the investment team has recognized increasing uncertainty in interest rates due to changing economic forecasts, including inflation expectations and potential shifts in monetary policy by the Federal Reserve.

As the lead portfolio manager, you are tasked with reassessing the interest rate risk in the portfolio. Your objective is to ensure that the portfolio achieves its targeted return, while effectively managing interest rate exposure. Provide a comprehensive analysis that addresses the following:

• Assess the potential impact of rising and falling interest rates on the different segments of the portfolio.
• Discuss strategies to mitigate interest rate risk, including duration management, use of derivatives, and sector allocation adjustments.
• Evaluate the trade-offs associated with each mitigation strategy, considering the potential impacts on portfolio performance under different interest rate scenarios.

Support your analysis with appropriate examples and rationale.