It is August 2 and a fund manager with $20 million invested in government bonds is concerned
Question:
It is August 2 and a fund manager with $20 million invested in government bonds is concerned that interest rates are expected to be highly volatile over the next 3 months. The fund manager decided to use the December T-bond futures contract to hedge the value of the portfolios. The current futures price is 94-04. Each contract is for the delivery of $100,000 face value of bonds. Suppose that the duration of the bond portfolio in 3 months will be 7.40 years. The cheapest-to-deliver bond in the T-bond contract is expected to be a 20-year 8% per annum coupon bond. The yield on this bond is currently 6%, and the duration will be 8.20 years at maturity of the futures contract. Discuss how the fund manager would hedge and show how he can avoid the interest rate risk.
Fundamentals of corporate finance
ISBN: 978-0470876442
2nd Edition
Authors: Robert Parrino, David S. Kidwell, Thomas W. Bates