Question $2-15$ marks

You are a financial manager, and you have bonds worth $$1,550,000$ in your portfolio which have a $7$ percent coupon rate and will be maturing in $10$ years from now. The market rate is also $7$ percent but is likely to either rise to $8\%$ or fall to $6\%$

Based on the above information, answer the following questions:

i$)$ What type of risk you are exposed to$?$

$(1$ mark$)$

ii$)$ How can you hedge your exposure using the information in parts iii$)$ and iv$)$ below?

$(2$ marks$)$

iii$)$ Suppose a call and put option on these bonds is available with an exercise price of $$1,700,000.$ These contracts are available in standard contract sizes of $100$ options per contract at a price of $$5$ per contract. Show the net impact of a change in market rates if options are used for hedging the exposure.

$(8$ marks$)$

iv$)$ If a futures contract on these bonds is available with a standard contract size of $$155,000$ per contract, show what will be the net impact of a change in market rates if futures are used for hedging the exposure.

$3$

v$)$ Which hedge provides better results? Why?

$(2$ marks$)$

$(2$ marks$)$