Cheapest to Deliver

balajismz
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Joined: Mon Nov 05, 2012 9:13 am

Cheapest to Deliver

Postby balajismz » Tue Nov 06, 2012 8:13 am

Can someone try this??

It is June 2nd and a fund manager with USD 10 million invested in government bonds is concerned that interest rates will be highly volatile over the next three months. The manager decides to use the September Treasury bond futures contract to hedge the value of the portfolio. The current futures price is 95.0625. Each contract is for the delivery of USD 100,000 face value of bonds. The duration of the manager’s bond portfolio in three months will be 7.8 years. The cheapest to deliver bond in the Treasury bond futures contract is expected to have a duration of 8.4 years at maturity of the contract. At the maturity of the Treasury bond futures contract, the duration of the underlying benchmark Treasury bond is 9 years. What position should the fund manager undertake to mitigate his interest rate risk exposure?
Choose one answer.
a. Short 98 contracts
b. Short 113 contracts
c. Short 94 contracts
d. Short 105 contracts

Balaji

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swarnendupathak
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Re: Cheapest to Deliver

Postby swarnendupathak » Tue Nov 06, 2012 9:26 am

We need to take the duration of only C2D bond i.e. 8.40 years... which makes the ans to be 98 contracts.

Swarnendu

content.pristine
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Re: Cheapest to Deliver

Postby content.pristine » Thu Nov 08, 2012 1:23 pm

You need to balance the risk of the portfolio with the risk of the Futures.
Total Risk of the Portfolio = Duration * Portfolio Value = 7.8*10,000,000 = 78,000,000
Now, 78,000,000 = Dur of Fut * Fut Price * Number of Future Contracts
78,000,000 = 8.4 * 95.0625 * Number of Future Contracts
Number of Future Contracts = 105.194

Hope this helps!
8-)

swarnendupathak
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Posts: 119
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Re: Cheapest to Deliver

Postby swarnendupathak » Thu Nov 08, 2012 1:43 pm

But by this formula the answer is 98 contracts...

Swarnendu

content.pristine
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Posts: 356
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Re: Cheapest to Deliver

Postby content.pristine » Fri Nov 09, 2012 5:27 pm

Thats right.
Thanks Swarnendu
8-)


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