CFA Examination Level II Mike Lane will have $5 million to invest in five-year U.S. Treasury bonds three months from now. Lane believes interest rates will fall during the next three months and wants...

CFA Examination Level II

Mike Lane will have $5 million to invest in five-year U.S. Treasury bonds three months from now. Lane believes interest rates will fall during the next three months and wants to take advantage of prevailing interest rates by hedging against a decline in interest rates. Lane has sufficient bonds to pay the costs of entering into and maintaining a futures position.

a. Describe what action Lane should take using five-year U.S. Treasury note futures contracts in protect against declining interest rates.

Assume three months have gone by and, despite Lane"s expectations, five-year cash and forward market interest rates have increased by 100 basis points compared with the five-year forward market interest rates of three months ago.

b. Discuss the effect of higher interest rates on the value of the futures position that Lane entered into in Part a.

c. Discuss how the return from Lane"s hedged position differs from the return he could now earn if he had not hedged in Part a.