Suppose a Bank of Texas (BoT) has an average asset duration of 9 years, an average liability
Question:
Suppose a Bank of Texas (BoT) has an average asset duration of 9 years, an average liability duration of 5 years, total assets of $600 million, and liabilities of $400 million at a given point in time. Suppose, too, that the firm plans to trade in Treasury bond futures contracts. The T-bonds named in the futures contracts have a duration of 10 years, and the T-bonds’ current price is $99,700 per $100,000 contract. How many futures contracts does a BoT need to cover a given size risk exposure? What is the change in net worth of BoT, if the interest rate decreases from 9% to 5%? As we notice that BoT have a positive duration gap (indicating its assets have longer average maturity than its liabilities). What sort of hedging strategy should BoT adopt if the interest rate declines?
