1. An FI holds a 15-year, par value, $10 million bond that is priced at 104 with a yield to maturity of 7 percent. The bond has a duration of eight years, and the FI plans to sell it after two months. The FI’s market analyst predicts that interest rates will be 8 percent at the time of the desired sale. Because most other analysts are predicting no change in rates, two-month forward contracts for 15-year bonds are available at 104. The FI would like to hedge against the expected change in interest rates with an appropriate position in a forward contract. What will this position be? Show that if rates rise 1 percent as forecast, the hedge will protect the FI from loss.

Contrast the position of being short with that of being long in futures contracts.