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June Klein, CFA, manages a $200 million (market value) U.S. government bond portfolio for an institution. She anticipates a small parallel shift in the yield

June Klein, CFA, manages a $200 million (market value) U.S. government bond portfolio for an institution. She anticipates a small parallel shift in the yield curve and wants to fully hedge the portfolio against any such change.

PORTFOLIO AND TREASURY BOND FUTURES CONTRACT CHARACTERISTICS
Conversion Factor Portfolio Value /
Modified Basis Point for Cheapest to Future Contract
Security Duration Value Deliver Bond Price
Portfolio 12 years $240,000.00 Not Applicable $200,000,000
U.S. Treasury bond futures contract 11 years $246.02 1 93-06

  1. Formulate Kleins hedging strategy using only the futures contract shown. Calculate the number of futures contracts to implement the strategy. Do not round intermediate calculations. Round your answer up to the nearest whole number.

    Kleins hedging strategy is to -Select-buy-sellI #__futures contracts.

  2. Determine how each of the following would change in value if interest rates increase by 12 basis points as anticipated. Use the rounded value of the number of futures contracts from part a. Round your answers to the nearest dollar. Enter your answers as positive values.
    1. The original portfolio.

      The market value of the original portfolio will -Select-declineincreasenot change by $ ?

    2. The Treasury bond futures position.

      The total cash -Select-inflowoutflow from the futures position will be $ .__

    3. The newly hedged portfolio.

      Theoretically, the change in the value of the hedged portfolio is -Select-zero, the change in value of the original portfolio, the cash flow from the hedge position

  3. State three reasons why Kleins hedging strategy might not fully protect the portfolio against interest rate risk.
    1. Immunization risk would remain even after execution of the strategy, because of the possibility of non-parallel shifts in the yield curve.
    2. Basis risk also exists between the T-bond futures and spot T-bonds, so that there would still be risk even if the government portfolio held only T-bonds.
    3. Because fractional futures contracts cannot be sold, the duration may not be able to be set exactly to zero.
    4. If interest rates decrease Kleins hedging strategy can not be applied. It means that the strategy protects the portfolio only against increase in interest rate.

    -Select-(1, 2,3) (1,2,4) (1,3,4) (2,3,4)

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