A mortgage banker had made loan commitments for $10 million in 3 months. How many contracts on Treasury bonds futures must the banker write or buy?

Question

Quizplus · Accepted Answer

To hedge the mortgage loan commitments, the banker needs to go short on Treasury bond futures because as interest rates rise, the value of the bonds (and therefore the futures contracts) will fall, offsetting any losses on the loans. The rule of thumb is to use a hedge ratio of 80-90%, meaning that the value of the futures contracts should be 80-90% of the value of the loan commitments. Therefore, the banker should go short on Treasury bond futures contracts worth $8-9 million, which would equate to approximately 100 futures contracts (each with a face value of $100,000).

A Mortgage Banker Had Made Loan Commitments for $10 Million