CFA Examination Level III
June Klein, CFA, manages a $100 million (market value) U.S. government bond portfolio for an institution. She anticipates a small parallel shift in the yield curve and wants to fully hedge the portfolio against any such change.
PORTFOLIO AND TREASURY BOND FUTURES CONTRACT CHARACTERISTICS
|
Security
|
Modified
Duration
|
Basis Point
Value
|
Conversion
Factor for
Cheapest to
Deliver Bond
|
Portfolio
Value/Future
Contract Price
|
Portfolio
|
10 years
|
$100,000
|
Not Applicable
|
$100,000,000
|
U.S. Treasury
bond futures
contract
|
8 years
|
$75.32
|
1
|
94–05
|
a. Discuss two reasons for using futures rather than selling bonds to hedge a bond portfolio. No calculations required.
b. Formulate Klein’s hedging strategy using only the futures contract shown. Calculate the number of futures contracts to implement the strategy. Show all calculations.
c. Determine how each of the following would change in value if interest rates increase by 10 basis points as anticipated. Show all calculations.
(1) The original portfolio
(2) The Treasury bond futures position
(3) The newly hedged portfolio
d. State three reasons why Klein’s hedging strategy might not fully protect the portfolio against interest rate risk.
e. Describe a zero-duration hedging strategy using only the government bond portfolio and options on U.S. Treasury bond futures contracts. No calculations required.