On August 2. a securities dealer. Ms. C\'indy Zaicko. responsible for a $10 mill
ID: 2717443 • Letter: O
Question
On August 2. a securities dealer. Ms. C'indy Zaicko. responsible for a $10 million bond portfolio is concerned that interest rates arc expected to be highly volatile over the next 3 months. The fund manager decides to use Treasury bond futures to hedge the value of the bond portfolio. The current price on a December T-bond futures is 91-22. During the period August 2 to November 2. interest rates climbed rapidly causing the bond portfolio value to drop as prices of T-Bonds declined from 100-00 to 95-11. On November 2. the December T-Bond futures contract was priced at 88-26. The portfolio was sold at its market value on Nov. 2. The minimum contract size for the T-Bond futures contract is S 100.000 and the minimum price change is $31.25 per tick of 1/32. State what kind of hedge could Ms. Zaicko take and why. Compute the opportunity cost of waiting to the portfolio. Describe all transactions clearly Compute gain or loss in the futures market after describing the transactions.Explanation / Answer
a)Zaicko should short T-Bonds futures to hedge his Bond portfolio.He is exposed to adverse movements in interest rates therefore he should eliminate this exposure by going short on T-Bonds futures.He gains from interest rate climbs by short T-Bonds futures so that this gain offsets any loss arising due to interest rate climb in his portfolio and provide the right hedge.
b)after interest rate movement,
The loss in Bond portfolio=((95+11/32)-100)*1000,00=-465,625
If portfolio sold now only w/o waiting revenue in Bond portfolio=10,000,000
If portfolio sold after waiting revenue in Bond portfolio=(95+11/32)*100,000=9534375
opportunity cost of waiting=The loss in Bond portfolio=9534375-10,000,000=-465,625
c)The no of contracts of T-Bonds futures required for hedge=-(10,000,000)/(91.6875*100,000)=-1.1~-1 contract ((91.6875=91-22=91+22/32)
short futures at price of 91-22=(91+22/32)=91.6875
take offsetting position of long futures and close position at futures price of 88-26= (88+26/32)=88.8125
The gain in futures contract= -$(88.8125-91.6875)*size of contract*# contracts
The gain in futures contract=-$(88.8125-91.6875)*100,000*1=287500
d)The effective loss after hedge=-465,625+287,500=-178125
The effective revenue after hedge=100*100,000-178125=9821875
The effective revenue after hedge=(95+11/32)*100,000+287,500=9534375+287,500=9821875 where 287,500 is gain from the futures position and (95+11/32)*100,000 is value of bond portfolio obtained after selling the portfolio after interest rate climb.
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