An FI holds a 15-year, $10m par value bond that is priced at 104 and yields 7.5%

Question

An FI holds a 15-year, $10m par value bond that is priced at 104 and yields 7.5%. The FI plans to sell the bond in two months. The bond has a duration of 9.7 years. The FI forecasts implies that the Federal Reserve will raise interest rates within the next two months to 8.4%. Available are 2-month forward contracts for 15-year bonds at 104. The FI would like use forward contracts to hedge against the forecasted increase in interest rates. a) What position should the FI take? b) Show that if rates rise by 1% as forecasted, the bank hedge will protect the FI from loss

Explanation / Answer

An FI holds a 15-year, $10m par value bond that is priced at 104 and yields 7.5%

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