1. Define the following terms as they pertain to futures markets: speculator, hedger, long position, short position, spot market, margin, margin call. Suppose a bond dealer wants to hedge its inventory of Treasury bonds. The dealer is holding $15 million worth of T-bonds with a modified duration of 15 years. The futures contract, currently priced at 161, has a modified duration of 18 years. Compute the number of contracts required to hedge the position, indicate whether you would go long or short, and explain how the hedge works.

2. Discuss how interest rate futures can be used to immunize a portfolio from interest rate risk. Explain how a portfolio manager would use futures contracts to shorten the duration of a bond portfolio. Explain why a portfolio manager might rather use futures contracts instead of trading actual bonds in the spot market.

Suppose a financial institution currently has a positive duration gap. How would its net worth be expected to vary with changes in interest rates? Explain. Explain how a financial institution could immunize its net worth from changes in interest rates.

7. Explain how the addition of the following securities would likely impact the duration of a portfolio of intermediate-term bonds: Long position in T-bond futures, short position in T-bond futures, floating- rate notes.