Question: An FI holds a 15 year 10 000 000 par value bond
An FI holds a 15-year, $ 10,000,000 par value bond that is priced at 104 and yields 7 percent. The FI plans to sell the bond but for tax purposes must wait two months. The bond has a duration of 9.4 years. The FI’s market analyst is predicting that the Federal Reserve will raise interest rates within the next two months and doing so will raise the yield on the bond to 8 percent. Most other analysts are predicting no change in interest rates, so presently plenty of two- month forward contracts for 15- year bonds are available at 104. The FI would like to hedge against this interest rate forecast with an appropriate position in a forward contract. What will this position be? Show that if rates rise by 1 percent as forecast, the hedge will protect the FI from loss.
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