Interest Rate Risk Management in Fixed Income Portfolios

As a fixed income portfolio manager at a large investment firm, you have experienced an unprecedented shift in interest rates following a period of low inflation and stable economic growth. The Federal Reserve has indicated a significant tightening of monetary policy due to unexpected inflationary pressures. You are tasked with reassessing your fixed income portfolio which consists of a diverse array of bonds including government securities, corporate bonds, and municipal bonds.

Discuss the steps you would take to assess the interest rate risk of your current portfolio. In your response, elaborate on the specific quantitative measures you would employ, including but not limited to duration and convexity analysis. Furthermore, consider how you might adapt your portfolio strategy in response to the anticipated increase in interest rates, and the potential implications for the different asset classes within your portfolio.

Additionally, include a discussion on the importance of scenario analysis and stress testing in managing interest rate risk, as well as any potential hedging strategies you might consider implementing. Your answer should reflect a comprehensive understanding of fixed income portfolio management and the critical factors influencing interest rate risk.