Question

1. A bond future currently bond portfolio with a face value $10 million. The current market value of the portfolio is only 92.2% of face, however. The fund managers anticipate a rise in bond yield in the near future so they desire a T-bond hedge strategy to protected themselves.

1. Given their rate expectations, should they short or go long in T-bond futures? Explain
2. The risk manager use $100,000 face value T bond contracts. If they use a 1-1 (naïve) hedge ration between cash and futures position how many contract should they use if they hedge the market value of the portfolio?
3. The deliverable bonds are 10 3/4% ( 10.75%) with conversion factor of 1.2922. if accrued interest is zero what cash amount would be transacted per contract if the quoted future price is 76-31?
4. At close the market value of the bond portfolio is now 90.2% of face. The cash amount transacted per contract is .97458 times the face value of the future contract. Calculate the loss in the bond portfolio market value versus the change in value of the hedge.
5. Did the hedge work? explain

Answer 1

a. Since the fund managers anticipate a rise in bond yield in the near future, the bond price in the future will be further discounted, resulting into fall in the price of bond; as a result the price of bond future will also fall. Hence the T Bond future should be short.

b. 1-1 hedge ratio

no of contracts to be short= Market Value of Portfolio/ (Face value of T Bond Futures)= $9220000/100000= 92 Contracts