![2. [6 marks] JP Morning bank has a considerable number of bond securities on its balance sheet. It is worried about changes i](http://img.homeworklib.com/questions/e1ca98f0-79f2-11ea-852a-311442faa6fe.png?x-oss-process=image/resize,w_560)
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2 a.Bank should be worried about increase in interest rate. If the interest increases, the bond value will decrease.The futures contract to mitigate the risk will be SELL bond futures ie Short contract.
Because , bank will make profit in short contract if the bond value decreases which will offset the loss in holding
b. Bond value will decrease as the interest rate increases.
Payoff line representing the bond is downward sloping
Payoff line does for bonds does not go through the origin
Payoff on future contract will increase as the interest rate increases
Payoff line representing the Futures Contract is upward sloping
Payoff line for futures contract does not go through the origin.
c.If Bond price go down from 100 to 99: Payoff=-1
If short futures go down from 105 to 104: Payoff =1
Value of combined folio will remain unchanged.
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