A bond portfolio manager has a $25 million market value bond portfolio with a 6-year duration. The manager believes interest rates may increase 50 basis points. Which of the following could be used to help limit his risk?
I. Sell the bonds forward.
II. Buy bond futures contracts.
III. Buy call options on the bonds.
IV. Buy put options on the bonds.

Question

Quizplus · Accepted Answer

Selling bonds forward or buying options can help limit the risk of an increase in interest rates. However, since the manager believes interest rates may increase, buying bond futures contracts (II) will not be a helpful choice as it requires taking a long position in the market. Instead, the manager may consider selling bonds forward (I) or buying put options on the bonds (IV) to benefit from a decline in bond prices resulting from the increase in interest rates. Buying call options on the bonds (III) would not be a helpful choice as it would only benefit if bond prices increase. Therefore, the best choices to limit risk would be selling bonds forward (I) and/or buying put options on the bonds (IV).

A Bond Portfolio Manager Has a $25 Million Market Value