Answer Happy

1. A fund manager invested $10 million in government bonds (trading at par) is concerned about an increase in interest rates over the next 3 months. The manager decides to use the T-bond futures contract to hedge the portfolio. Current futures price is 96-02 (treasury bond futures follow the T- note/bonds price quote convention). The modified duration on the bond portfolio is 6.80 years. The CTD issue has a modified duration of 9 years. Devise a hedge for the manager? (Hint: You need to find the PVBP of the portfolio and the futures contract using the following formula: PVBP =- Modified Duration *P*0.01%.). 2. Suppose a financial institution has a duration gap of -5 years and $10 million in assets. The cheapest to deliver bond for Treasury futures contracts has a duration of 3 years. How will the manager hedge this interest rate risk? Assume the cheapest to deliver bond is trading at par (futures contracts have a par value of $100,000). (Note: This problem is independent from the previous one).