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Essentials Of Investments
Found in: Page 590
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

A corporation plans to issue $10 million of 10-year bonds in three months. At current yields the bonds would have modified duration of eight years. The T-note futures contract is selling at F0 = 100 and has modified duration of six years. How can the firm use this futures contract to hedge the risk surrounding the yield at which it will be able to sell its bonds? Both the bond and the contract are at par value.

Sale 133 contracts to offset losses

See the step by step solution

Step by Step Solution

Step 1: Given information

Bond value = $10,000,000

Modified duration = 8 years

Since the contracts and yield changes on bond are 1 basis point, hence the change in bond value = $10,000,000 x 0.0001 x 8


Step 2: Calculation of cash flow

The cash flow on account of contract = $100,000 x .0001 x 6 (given)

= $60

This implies that the manager should sell 8000 / 60 = 133 contracts

This sale would offset losses in case the interest rates increase.

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