bank holds a 5-year par value bond of $5million. The duration of the bond is 4 years. The bond is currently priced at $5.1 million with a yield to maturity of 5 per cent. The bank intends to sell the bond in one months time, but the bank expects that interest rates may increase with 1 per cent before the bond will be sold. The bank would therefore like to hedge against the expected change in interest rates with an appropriate position in a forward contract.

Questions:

a. What position (buy or sell) will the bank take in the forward contract? (0.5 mark)

b. How will the forward contract protect the bank against the change in the bond value calculated in question 18?(1 mark)