Question 7 (20 marks) At date, the portfolio P to be hedged is a portfolio of Treasury bonds with various possible maturities. Its characteristics are as follows: YTM Value $1,450 MD 4.25 Convexity 55 6% We consider Treasury bonds as hedging assets, with the following features: Price (s) Bond Bond 1 Bond 2 Bond 3 108 118 98 Coupon Rate(%) 6 5 Years to Maturity 3 years 4 years 5 years Coupon frequency and compounding frequency are assumed to be annual. Face value of the three bonds is assumed to be $100. We DONOT force the hedging portfolio to have the opposite value of the portfolio to be hedged. 1. What is the number of hedging instruments necessary to implement a modified duration and convexity hedge? Explain why. 2. Compute the YTM, modified duration and convexity of the hedging assets needed. 3. What are the numbers of hedging assets that we need to hedge the portfolio in terms of duration and convexity? Question 7 (20 marks) At date, the portfolio P to be hedged is a portfolio of Treasury bonds with various possible maturities. Its characteristics are as follows: YTM Value $1,450 MD 4.25 Convexity 55 6% We consider Treasury bonds as hedging assets, with the following features: Price (s) Bond Bond 1 Bond 2 Bond 3 108 118 98 Coupon Rate(%) 6 5 Years to Maturity 3 years 4 years 5 years Coupon frequency and compounding frequency are assumed to be annual. Face value of the three bonds is assumed to be $100. We DONOT force the hedging portfolio to have the opposite value of the portfolio to be hedged. 1. What is the number of hedging instruments necessary to implement a modified duration and convexity hedge? Explain why. 2. Compute the YTM, modified duration and convexity of the hedging assets needed. 3. What are the numbers of hedging assets that we need to hedge the portfolio in terms of duration and convexity