JP Morning bank has a considerable number of bond securities on its balance sheet. It is worried about changes in the interest rate and would therefore like to engage in bond futures contracts.

a. Should the bank be worried for interest increases or decreases? What type of bond futures contract would you recommend (long or short)?

For the remainder of this question, assume that the bank has just 1 bond with a current bond price of 100. Ignore the existence of multipliers on future contracts, so that one future contract has one bond as underlying asset.

b. If you would draw the payoff lines for the bond and for the future contracts, how would both lines look like?

The payoff line representing the bonds is an upward / downward sloping line.

The payoff line for the bonds does go / does not go through the origin.

The payoff line for the futures contract is an upward / downward sloping line.

The payoff line for the futures contract does go / does not go through the origin.

c. If both the bond price and the futures price go down by 1 (i.e., bonds from 100 to 99 and futures from 105 to 104), how does that affect the value of the combined portfolio? Please give the computation (you do not have to show it in the graph).