An Australian Commonwealth Government Security (CGS) has a maturity date of 15 March 2024. The CGS is paying a coupon of 6% p.a. and is priced at a yield of 8% p.a. The CGS pays coupons semi-annually on the 15th of the relevant coupon payment month. The settlement date of the trade in this bond is 24 July 2022. There is a zero coupon bond with exactly two years until maturity (i.e. the maturity date is 24 July 2024). The zero coupon bond has a yield to maturity of 8%. The yield curve is flat at 8% per annum. 

Please use semi-annual compounding when answer the following questions.

a) If you have $2 million invested in the CGS, how many of the 2-year zero-coupon bonds would you need to short-sell to hedge your interest rate risk?

 
b) Without doing any calculations, discuss what actions you would need to take with your short position in the zero coupon to ensure you remain hedged until the maturity of the coupon paying bond. Why do you need to take these actions?

Answer rating: 100% (QA)

The detailed answer for the above question is provided below Part a Hedging Interest Rate Risk To hedge interest rate risk you need to determine how many 2year zerocoupon bonds to shortsell in order t... View the full answer