let’s assume you are working for a bank or investment bank, in charge of hedging
ID: 2811111 • Letter: L
Question
let’s assume you are working for a bank or investment bank, in charge of hedging the interest rate risk. The bank has invested $500 million in bonds, but you expect the interest rate to rise in the coming months further due to higher expected inflation rate. How do you hedge this bond portfolio since you know that this will impact the bond value of your portfolio? Hint: you may use T-bill futures contracts or T-Notes or T-bond futures and please make sure to indicate the number of contracts and the long or short position.let’s assume you are working for a bank or investment bank, in charge of hedging the interest rate risk. The bank has invested $500 million in bonds, but you expect the interest rate to rise in the coming months further due to higher expected inflation rate. How do you hedge this bond portfolio since you know that this will impact the bond value of your portfolio? Hint: you may use T-bill futures contracts or T-Notes or T-bond futures and please make sure to indicate the number of contracts and the long or short position.
let’s assume you are working for a bank or investment bank, in charge of hedging the interest rate risk. The bank has invested $500 million in bonds, but you expect the interest rate to rise in the coming months further due to higher expected inflation rate. How do you hedge this bond portfolio since you know that this will impact the bond value of your portfolio? Hint: you may use T-bill futures contracts or T-Notes or T-bond futures and please make sure to indicate the number of contracts and the long or short position.
Explanation / Answer
The investment banker who have positions in long-term bonds are sensitive to interest-rate changes to hedge interest rate risk one should take positions using T-Bond futures. When interest rates rise, there would be a price drop in bond portfolio he can offset by a gain in the value of his short position in T-Bond futures contracts. He would sell a futures contract to offset interest-rate risk on bonds portfolio. Face Value of T-Bond futures contract = $100,000.00 Amount Invested in Bonds $500,000,000.00 # of Contracts = $500,000,000/$100,000 5,000.00 contracts
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