A bond portfolio manager expects a cash outflow of $35,000,000. The manager plans to hedge potential risk with a Treasury futures contract with a value of $105,215. The conversion factor between the CTD and the bond specified in the Treasury futures contract is 0.85. The duration of bond portfolio is eight years, and the duration of the CTD bond is 6.5 years. Indicate the number of contracts required and whether the position to be taken is short or long.
A) 333 contracts short
B) 333 contracts long
C) 348 contracts short
D) 348 contracts long
E) 300 contracts long

Question

Quizplus · Accepted Answer

To determine the number of contracts required, we need to first calculate the hedge ratio. The hedge ratio is calculated as follows:
Hedge Ratio = (Dp / Df) x (Vp / Vf) = (8 / 6.5) x (35,000,000 / (105,215 x 0.85))
Hedge Ratio = 506.9
Next, we need to round the hedge ratio to the nearest integer, which gives us 507.
Finally, we divide the cash outflow by the contract value to get the number of contracts required:
Number of Contracts = Cash Outflow / (Contract Value x Conversion Factor x Hedge Ratio)
Number of Contracts = 35,000,000 / (105,215 x 0.85 x 507) = 348.12
Since we cannot trade a fractional number of contracts, we round up to 348 contracts. The position to be taken is short, since the manager is hedging a potential cash outflow. Therefore, the best choice is C) 348 contracts short.

A Bond Portfolio Manager Expects a Cash Outflow of $35,000,000